Oligarch expects adopted homeland to blossom

Financial News: Focus on Russia

Jason Corcoran in Moscow

30 July 2007




Stephen Jennings, founder of Russian investment bank Renaissance Capital keeps the faith in his new country

It’s clear Moscow is going to be a major capital market

Stephen Jennings, founder of Russia’s Renaissance Capital, may spend as much time in Nairobi expanding the bank’s sub-Saharan operations as in Moscow but he is not betting against the domestic market just yet.

The billionaire, one of two foreign oligarchs in Russia, made his fortune by keeping faith in the country and his investment banking business, which both came close to collapse after the financial crisis of 1998.

Having seen that out, the New Zealander is unlikely to pack his bags for home soon. Nor is he sitting on his laurels, having seen Renaissance break into the top 10 global underwriters of initial public offerings for the first time last month.

Jennings envisages Moscow becoming Europe’s second financial capital behind London, overhauling Frankfurt, Paris and Milan within 15 years.

He said: “It’s clear Moscow is going to be a major capital market. It already is in new issuance and overall market capitalisation. Imagine what’s going to happen with another 10 years of capital accumulation, and how big the domestic capital markets will be.

“Mortgage markets, securitisations markets and derivative markets will be very big. It sounds strange but when you think about it, it’s totally logical.”

Russia has the biggest and most liquid stock market in the region by far, with a market capitalisation of more than a $1 trillion (€723bn). It turns over billions of dollars every day. Its companies were third in the world in terms of fundraising through IPOs in the first half of the year, outpacing the UK and Brazil, according to auditor Ernst & Young.

Jennings admitted that beyond equity issuance, Russia lags its rivals. In terms of foreign exchange trading, commodities, debt and derivatives, Moscow is not on the global radar, he said. But this is changing. Derivatives are now the fastest growing area of Russia’s financial sector as the scale and diversity of Russia’s asset base and securities markets drives its development.

Jennings said Moscow could become the focus of an emerging regional capital market, although it would have to compete with Warsaw, which has attracted several Ukrainian IPOs.

He added: “We will start to see elements of a pan-CIS capital market and it’s more likely than not to be centred on Moscow. When markets get to a certain size, political pressure for that harmonisation will get to be a lot greater. We will see pan-CIS investment banks, we will see pan-CIS commercial banks and that’s starting to happen now.”

Moscow forms a natural bridge between Asian and European markets. For it to develop as a financial hub, Jennings said more widespread equity ownership and growth in domestic pension funds, mutual funds and insurance funds would be needed. Renaissance’s own fund arm, Renaissance Investment Management, is Russia’s market leader and has grown rapidly to $4.5bn in assets under management.

Some signs are encouraging, such as May’s IPO by state-controlled bank VTB. It was the first meaningful allocation of shares to retail investors. More than 131,000 of them applied for stock valued at approximately $1.6bn.

Institutional reform is vital to developing Russian capital markets and Jennings noted its pace has slackened recently, compared to the rate of change in Kazakhstan and Ukraine.

He said: “Russia has been quite good at cutting tax rates or streamlining and simplifying but it hasn’t been very good, so far, at building strong institutions. There will be another phase of reform and then Russia will go through a phase of modernising its institutions. Some aspects of capital market development will have to wait for that phase.”

Jennings said lack of banking reform has hampered financial intermediation and efficiency in financial systems, but has not affected the participation of foreign banks in Russia.

Foreign banks, including France’s Société Générale and Belgium’s KBC Group, were snapping up Russian lenders to gain a foothold in the booming consumer credit market, he said. Deutsche Bank, Barclays and HSBC have all recently outlined plans to enter the retail market.

“The market is substantively quite liberal in terms of foreign banks’ participation,” said Jennings.
“The global banks have not had the strategic commitment until now. They underestimated the opportunity and now they are paying for it.”

Investment banking was the most developed industry in Moscow, he said, with 37 companies, at the last count, scrabbling for clients.

A war for talent has been under way for a year and Renaissance has played its part. Recent hires include Petri Kivinen, global head of debt capital markets at Dresdner Kleinwort in London, Gordon McCulloch, co-head of Goldman Sachs’ Moscow office, and Richard Bruens, head of investor relations at ABN Amro.

“There are a lot of open cheque books out there and I don’t think paying a lot is enough to retain people in any environment – and certainly not in a really hot environment,” said Jennings.

Renaissance’s investment bank has more than 1,000 employees in Moscow and Jennings claims to have lost only one director to a rival over the past two years.

Renaissance is a private partnership and more than 100 employees own a stake in it. Employees who leave receive the book value of their stock which, while significant (it is valued at $1bn), does not represent its likely market value. Jennings owns 80% of the business, a stake that has been valued by bankers at between $3bn and $4bn.

Jennings is not concerned that forthcoming elections will affect his business adversely and, like many of Moscow’s leading bankers, he diplomatically refuses to be drawn into backing a successor to President Putin.

He said: “Putin brought a much-needed degree of stability when we had a large measure of anarchy. The name of the game now is going to be continuity: continuity politically and a high degree of continuity in terms of how the economy is developing.”

• Rencap’s strategy presents a strong case for joint venture

Rencap’s growth strategy is based on exporting its Russian business model to other emerging markets and developing alliances with leaders in other fields.

Jennings said Renaissance plans to increase the investment banking services it offers in frontier markets, having set up in sub-Saharan Africa and CIS countries including Kazakhstan and Ukraine. The bank is also expected to announce details of an infrastructure joint venture with Australian banking group Macquarie.

Jennings said going it alone was not an option for Renaissance. He said: “Unlike equity capital markets where we can create scale to have the best sales and best capital market professionals, it is very questionable that a go-it-alone model is efficient if you want to be strong in infrastructure. There is a strong case for us to team up with somebody – I think infrastructure is going to be one of the next big developments in Russia.”

The bank has an investment banking joint venture with the Royal Bank of Scotland and an informal M&A tie-up with Lehman Brothers. The latter is strengthening its Moscow operation and has recruited leading rainmaker Nick Jordan from Deutsche Bank to spearhead its push,

Denying this would jeopardise the alliance, Jennings said: “When Nick was running Deutsche, Renaissance used to do a lot of business with them. We would see Nick joining Lehman as a positive and certainly not a negative. There is some overlap but in terms of resources on the ground and critical mass, there is not much overlap.”

Rencap will limit the number of alliances it entered into, according to Jennings. He said: “You can’t do a lot of alliances. How many best friends can you have? You can only have a small number. The RBS joint venture in derivatives gives us a leading position in a market that we would otherwise be a two-bit player in.”

Jennings said the bank has a billion dollars invested in its sub-Saharan projects focused on Nigeria and Kenya. “We have a big challenge in Africa over the next 12 months but we don’t rule out looking at other markets.” Renaissance has no plans to sell to a rival or to float the company, despite its successes floating other Russian businesses.

Jennings, who set up Rencap in 1995 with a Credit Suisse colleague Boris Jordan, has rebuffed interest in the business from western banks and state-owned VTB. He said selling, as rival brokerages Brunswick and UFG have, would ruin Rencap’s reputation for providing clients with impartial and independent services.

He said: “It would be very damaging and what you sold would be slightly damaged by the time you sold it.

“By virtue of the sale process, you would lose something. We have seen that has happened in the market here.”

Putin unlikely to allow political risk to spoil the Russian party

Financial News: Focus on Russia

Market participants give their views on three critical questions about the country’s political climate

We do not expect Indonesian-style instability in Russia and the process will be carefully stage-managed by outgoing President Putin and the Kremlin - Chris Weafer, Alfa Bank


1 Could the political situation between Russia and the UK damage capital market activity between the two countries?

2 What are the main risks to capital market activity and the Russian equity markets posed by the upcoming elections?

3 If Putin goes, who will best secure investor confidence in Russia’s economy?

Roland Nash

Head of research,
Renaissance Capital

1 Political relations between Russia and the UK may have fallen to the lowest level since the Soviet era but financial and business ties have never been stronger.

On the same day as the UK expelled the four Russian diplomats, the Russian equity market posted its highest close. The UK, for the first time, became the biggest source of foreign direct investment into Russia in the first half of this year – roughly $5bn (€3.6bn).

London is the city of choice both for companies to list and for Russians to live. There is an enormous vested interest on the Russian side and the UK side to make sure business channels remain open.

If business relations are better than ever, despite the difficult diplomatic relations, then it seems to me it will take much more than the current diplomatic confrontation to undermine capital market activity.

2 There are three outstanding questions concerning the Russian elections. Who will be Russia’s next President? What will Putin do next? How will the interests of the elite be protected under the next President?

While the answers to these questions remain unanswered, there is an added risk premium to investing into any Russian asset. Perhaps the biggest risk is the elite attempting to grab private sector assets for personal reasons and because it plays well to the domestic electorate. If property rights receive another public bashing, it will scare away potential investors.

3 The current, rather simplistic, consensus is that Dmitri Medvedev is the good guy in the election race, and Sergei Ivanov is the bad guy. The situation is far more nuanced.

Medvedev is probably more business-friendly than Ivanov, although the difference between them is quite small. They both believe Russia needs a strong economy to be a powerful country, and that a strong economy in the modern world requires a private market. Equally, they both believe the state has a large role to play in the economy. Against the more business-friendly image, Medvedev is probably weaker than Ivanov.

In Russia, stability has historically been perhaps the fundamental requirement for economic success. Therefore, while the market may initially take an Ivanov presidency badly, I think in the longer run, he could prove a better President, from the perspective of protecting investment, than Medvedev.

Mattias Westman
Chief executive,
Prosperity Capital

1 No. There have been problems for some time and initially some people were hesitant but those people were generally not investors. The private sector is driving the capital markets and they are not very concerned.

Also the Russian companies do not have a realistic alternative since the New York Stock Exchange has become unattractive to foreign companies post-Sarbanes-Oxley.

2 The elections are unlikely to create much uncertainty. Putin will most likely indicate his support for a candidate and his popularity will be enough to carry that candidate to power.

The parliamentary elections in December might be more interesting since it is less of a winner takes all. There the main uncertainty is if the communists or nationalists have a strong showing. It is unlikely but a potential risk.

3 Russian entrepreneurs are the main investors in the Russian economy and they appear to be confident. Investment is booming, even ahead of the elections. This is a good indicator of private sector confidence and of its estimate of political risk.

Chris Weafer
Chief strategist,
Alfa Bank

1 If the situation were to escalate, then it is possible that as well as damaging trade and investment relations between the UK and Russia, it would then also cause a problem between Russia and the EU. But I do not think that this will be allowed happen. It is not in the interests of either country to allow this row to escalate beyond the diplomatic arena.

Clearly the UK had to make some response to events and it was timely for the new Prime Minister to make a strong statement. Russia’s response has been well balanced and it has said it will not escalate.
With the summer holidays coming up, I expect both sides will be happy to see this situation calm down. It will be a backdrop issue for a long time to come and prevent a friendly relationship between both governments.

But business leaders and investors just want a pragmatic relationship. That is what is most likely now that the tit-for-tat moves have been made. Russians have adopted Chelsea as a proxy national team and west London as a home from home. Come the start of the English Premier League next month, the mini-crisis will give way to the real passion that is football. And don’t forget that England and Russia face each other in crucial Uefa Cup games in the autumn.

2 Political change in any emerging market causes concern to investors and investment activity. Far too often when investors think election and emerging market, they think Indonesia. But we do not expect any of the Indonesian-style instability in Russia and the process will be carefully stage-managed by outgoing President Putin and the Kremlin.

There will be no instability but because it is a big election transition, it will cause some slowing of investment as investors play it safe.

I describe it more like the board of directors of a large corporation changing the chairman.

Most of the people in the Kremlin (the directors) will stay on the board, the policy objectives and working strategies of the country (the corporation) will remain unchanged and even the out-going President (chairman) will retain an important role.

3 The main effect may not be felt for two or more years, in other words, mid-way through the next presidency. That is the time when the country is most likely to face problems and hard choices.
That is when the choice of the next President will matter and also what role Putin has managed to retain.

Kim Iskyan
Co-head of research,
Uralsib Capital
1 I don’t think either the UK or Russia will let rhetoric get in the way of what has been a positive dynamic on the capital markets over the past few years. As in any relationship, there are ups and downs; this is a down, but I doubt politicians will let their tit-for-tat have an impact on their economic or financial relationship.

2 As uncertainty increases, perception of risk increases, boosting required returns and thus dampening activity and sentiment. There’s otherwise no real risk, in my mind.

Domestic loans frenzy attracts foreign buyers

Financial News: Focus on Russia

Jason Corcoran

30 July 2007



Booming demand for credit brings in multi-nationals

A consumer lending frenzy has gripped Russia with the resulting boom in mortgages, credit cards and consumer loans fuelling a mergers and acquisitions scramble in financial services.

Consumer lending had shot up to $80bn (€58bn) by the end of last year, from $20bn in 2004, according to Alfa Bank. Advertisements for “fast and easy credit” and “credit in 20 minutes” are plastered over Moscow’s Metro and in the city’s newspapers.

Mortgages total 0.9% of Russian’s GDP and other housing loans represent 1.4%. Moscow brokerage Aton Capital estimates 100 million Russians have never taken any kind of loan.

Foreign banks are keen to tap into this growing market and are snapping up medium and small-sized domestic banks.

This month, French financial group Société Générale, which had acquired a 20% stake in Rosbank, filed a request to exercise an option worth $1.7bn to take control of the Russia’s second largest retail bank. The deal is expected to be made at a record-high premium, with a price-to-equity ratio of 5.9.

Belgian bank KBC is set to pay $983m to acquire a 95% stake in second-tier mortgage bank Absolut Bank. The transaction is expected to close in the third quarter.

Other western banks building stakes in local banks include America’s Morgan Stanley, Austria’s Raiffeisen, Belgium’s Dexia, Germany’s Commerzbank, Nordic’s Nordea, Hungary’s OTP and Czech Republic’s PPF Group.

David Nangle, a banking analyst at Renaissance, said: “Following recent deals involving Raiffeisen, SG, OTP and some others, we firmly believe that the Russian banking market is now fair game for foreign bank investors, both from local banks’ willingness to allow foreign partners and international banks’ increasing appetite for Russian banking assets.”

President Vladimir Putin signed a law at the end of last year that put foreign investors on the same footing as Russians and allowed them to purchase of up to 20% in Russian banks without the approval of the central bank. Previously, foreign investors had to obtain regulatory approval for any level of ownership.

Of the multi-national finance companies, Citi is the most firmly established, having set up consumer banking in Russia in 2002. It serves more than 400,000 retail and 1,500 corporate clients from 60 local branches.

HSBC’s Russian subsidiary has received a licence to provide retail banking and is expected to have a limited network operating by the end of this year. HSBC chairman Stephen Green has said the sector in Russia is “crying out for good quality service from international competitors”.

Germany’s Deutsche Bank is considering adding consumer lending to its existing operations in corporate and investment banking and UK bank Barclays is due to open a Moscow office with 200 staff.

Rustam Botashev, a banking analyst at Aton, said he regarded Russia’s banking sector as the most attractive in the Commonwealth of Independent States because it has low levels of penetration, the country’s population is large and it has strong economic growth.

He said: “Untapped demand for retail banking services in Russia has attracted multi-national financial corporations to the country. These foreign banks are often in better positions than their Russian counterparts, thanks to cheap funding and strong expertise.”

Foreign ownership of Russian banks is set to rise from 12% to 18% by the end of this year, the Central Bank said. However, not all Russian banks are selling to foreign strategic investors.

The larger ones, including Troika, Alfa and MDM, are considering flotations, while recent IPOs by state-controlled Sberbank and VTB have increased the Russian banking industry’s capital by 25%.

The three state-controlled banks still have a strong hold over the market. Sberbank has a 50% share of retail deposits.

The remainder of the industry is highly fragmented said analysts. They say domestic banks would have to merge or be acquired by a larger company to fight off increased competition.

And, according to Aton, with the exception of VTB, most domestic banks face serious competition from foreign banks.

Its report said: “There are few Russian banks able to serve as a consolidator and therefore help the industry compete effectively against foreign institutions, which continue to strengthen their presence.

Russian banks lack access to cheap funding and have far less integration and retail banking expertise than their international counterparts.”

The insurance and asset management sectors have also attracted interest from foreign companies, although not to the same extent as retail banking.

In April, Germany’s Allianz took overall control of its insurance and fund management joint venture Rosno from its Russian partner Sistema.

Level of defaults causes concern

Unprecedented growth in the retail banking sector has highlighted some deficiencies. This month, US rating agency Fitch said a high degree fragmentation, high loan growth rates and a lack of regulation were sources of weakness in Russia’s financial industry.

James Watson, senior director in Fitch’s Institutions group, said: “Rapid growth of lending is a concern, although this is mitigated by moderate penetration and a supportive credit environment.

“Asset quality is generally sound, supported by the buoyant economy, but impairment is increasing in unsecured retail portfolios as loan books season.”

Russian independent agency RusRatings estimates that the total volume of overdue retail loans could be about 75.5bn roubles ($3bn), triple the 2006 figure.

Richard Hainsworth, chief executive of RusRatings, said some banks have been charging interest rates of more than 50% on consumer loans and this had led to a high number of defaults.

He said: “Russian banks advertise a nominal interest rate, as low as 10%, while effectively charging more than 50%. The remaining payments are for a wide variety of extra costs, such as a charge for opening the account, taking money from the account to pay for goods and insurance cover.”

Warning signs of a potential consumer credit bubble have been flagged in the Russian press.

Business daily newspaper Kommersant recently reported that Russian debtors were defaulting on approximately 35% of outstanding loans.

Yet Stephen Jennings, head of Renaissance Capital, which has its own consumer banking arm, said there was little to fear as credit penetration and household debt were low. He said: “I would be a thousand times more worried about debt in the good old USA than I would be in Russia.

“It’s an immature market, so that means you will have players who take on credit exposure that they don’t understand and that the market doesn’t understand.”

However, Jennings said only 4% or 5% of Renaissance’s debtors were defaulting on loans.

Belgium-Dutch group Fortis has a fund management alliance with KIT of St Petersburg and UniCredit subsidiary Pioneer Investments has announced its return to Russia after six years away.

St Petersburg opens investment route for infrastructure funds

Financial News: Focus on Russia

Jason Corcoran
30 July 2007


Kremlin hopes the world’s largest investors will participate in the country’s first PPP project

Infrastructure investments in Russia could grow to as much as $200bn (€145bn) over the next three years as the Kremlin seeks new funding sources to improve the country’s crumbling roads, bridges, ports and airports. The Government estimates private investors will stump up $30bn to finance Russia’s first large public-private partnerships.

The Kremlin also hopes the world’s largest international infrastructure funds will participate in Russia’s first landmark PPP project, a ring road encircling St Petersburg. A roadshow showcasing the project for investors will be held in London during September.

Macquarie Bank, the Australian infrastructure pioneer, is working with local brokerage Renaissance Capital to provide financing for the $3bn high-speed diameter motorway. The two banks are also expected to announce a formal joint venture to participate in infrastructure projects all over Russia.

Stephen Jennings, chief executive of Renaissance, said: “There will be hundreds of billions of dollars of projects. The infrastructure financing requirement is massive. Russia will be very pragmatic at adapting private sector solutions. There will be a lot of projects and a huge range.”

Yuri Soloviev head of global markets in Russia and the Commonwealth of Independent States at Deutsche Bank, said it would participate in PPPs through its advisory and corporate financing arms, as well as its infrastructure and property management unit Rreef.

He said: “Russia is too big for global or niche players to ignore. The big funds are looking at investing and we are going to be involved in as many ways as possible, through the advisory route or from the financing in terms of the equity or debt perspective, or from the investing angle.”

Deutsche Bank is also planning to launch infrastructure bonds in Russia next year to help finance the groundswell of state-backed and private infrastructure projects. Half of the cost of the high-speed road around St Petersburg is to be met by the Government’s Investment Fund, and the remainder by private investors and the city.

The International Finance Corporation, the European Investment Bank and the Nordic Investment Bank have expressed interest in financing the project.

The European Bank for Reconstruction and Development may invest up to $250m in the construction of the road, which is to be Russia’s test case for PPPs. The EBRD’s remit in Russia is to invest in transport infrastructure, municipal infrastructure and infrastructure in the power sector.

Natasha Khanjenkova, deputy director of infrastructure and energy in Russia at the EBRD, said the bank was looking to increase its investment significantly.

She said: “In 2006, we invested over €300m ($412m) in these sectors. However, we are working to increase significantly our investments in transport, municipal infrastructure and the power sector. Our strategy for Russia is to increase over the next few years the share of these sectors to between 35% and 45% of the bank’s annual commitments.”

A survey published earlier this month by Merrill Lynch indicated that infrastructure spending in Russia would amount to $195bn over the next three years. Other estimates suggest the figure could be closer to $300bn.

The Merrill report said the overall investment on projects in Russia and the Gulf would eclipse spending in China and India. The focus in Russia will be on improving the energy distribution network, as well as electricity and road projects. Real estate, especially in Moscow, is also booming.

Michael Hartnett, global emerging markets equity strategist at Merrill, said the private sector and Russia’s oil wealth and large budget surplus would meet the projected spend. He said: “The private sector will account for the bulk of the spending. This is because we estimate that energy-related spending will account for roughly 70% of total spend and this will be undertaken by energy companies such as Gazprom. Residual spending on transportation, logistics and housing will be by the Government.”

Threats to funding would chiefly come from political instability in Russia and a collapse in energy prices, according to Hartnett. Soloviev believes the chronic economic and social need for new infrastructure will over-ride any political change at the top.

He said: “However, there are additional risks not present in the west, such as the issue of property rights and the differences between federal and sub-federal law.”

For the first 10 infrastructure projects it has selected for tendering, the Ministry of Economic Trade and Development will invest $30bn of private money, a 20:1 ratio on the Government’s initial commitment of $1.5bn. Some industry experts believe this is a little ambitious. Public finance initiative projects in the UK are typically financed with 10% equity and 90% debt.

Other potential obstacles for PPP investment in Russia are the lack of practical experience and unresolved tax issues such as the laws governing concessions, which form an important legal framework for private investment in public utilities.

• Such is the scale of investment in St Petersburg that analysts are suggesting President Vladimir Putin wants his home city to become Russia’s capital once again.

The former imperial capital, the Russian empire’s seat of power for more than 200 years, is regaining some of its old lustre after high-profile infrastructure projects costing an estimated $15bn (€11bn) were agreed.

Chris Weafer, chief strategist at Alfa Bank, said: “These showcase projects suggest the Government may be looking to move the capital. They could be looking at moulding it into Russia’s Washington as a way of setting up an alternative power base to Moscow.”

Government financing is in place for works such as the Orlovsky tunnel under the Neva River and the Western High-Speed Diameter toll motorway around the city. Other projects in the pipeline include a high-speed toll road to Moscow, a sea passenger terminal, a football stadium, bridges, an airport and the reconstruction of the New Holland Island in the city centre.

Natasha Khanjenkova of the European Bank for Reconstruction and Development said the bank would consider entering into public-private partnership schemes such as the high-speed motorway and Orlovsky tunnel.

She said: “We hope this will be a success that will lead to other big PPPs in Russia. Because it is the first high-profile project involving PPPs, the western high-speed motorway will certainly prove a test case. Private sector firms interested in the project want it to succeed, but they are also seeking to share risks with the Government in order to structure a viable project.”

Arthur Rakowski, a director at Australian investment banking group Macquarie, said there could be an appetite from global funds if the first large PPP does well.

St Petersburg is not the only area to benefit from spending on infrastructure. Winter sports resort Sochi won the right to host the 2014 Winter Olympics last month, which should attract investment to the Krasnodar region of southern Russia.

Yevgeny Muravyev, its deputy governor, said private investment in the region could exceed $20bn in the run-up to the games. “There are plans to establish more than 3,000 investment sites and European investors have started showing great interest,” he said.

Main construction projects planned include 11 large winter sports facilities, an airport terminal, 200km of motorways and railroads, and the construction of hotels.

Governance concerns remain despite cosmetic improvements

Jason Corcoran

Financial News: Focus on Russia

Companies chasing international investment are trying to improve their image

Hostile takeovers, asset stripping, threats of imprisonment and violence have long been unpalatable features of doing business in Russia. Corporate governance was a little known concept even five years ago.

Critics claim it remains a myth and that reforms are cosmetic. However, Russian companies seeking international investment say they are responding to demands for greater accountability, independent directors and transparent corporate structures.

Stanislav Vartanyan, former chief executive of the Investor Protection Association, a Russian shareholder group, said: “The corporate world and the stock exchange here have made a quantum leap from the wild days when it was the law of the jungle. We now have a more civilised investor oriented culture.”

Vartanyan, who heads investor relations at Russia’s largest shipping company Fesco, is realistic about the extent of change required, but points to the declining influence of Russia’s oligarchs as being key to reform. Fesco has seen its share of controversy.

It was accused of extortion by a British investor and board member, and it was alleged that its ships spied on the US Navy and blinded pilots with laser beams.

Fesco’s main shareholder, the investment vehicle of former Energy Minister Sergei Generalov, has made several changes since buying a controlling stake in 2002 after a two-year campaign by the state to end shareholder conflict and stabilise management.

Vartanyan said: “One of the first things the new owners had on their agenda when they accumulated the controlling stake was to improve the company’s corporate governance, which at that time was typical for most Russian companies of that era – meaning there was no corporate governance at all.

“The new owners hired a new chief executive and a new chief financial officer, they introduced internal control procedures reporting to shareholders, the decision-making process was streamlined and the board of directors has become an efficient element of the company’s governance.”

Further changes have been made ahead of the Fesco’s initial public offering planned next year in London. Generalov has diluted his group’s shareholding from 80% to 64% while William Owens, former Colorado Governor and a friend of US President George W Bush, joined the ranks of independent directors.

Investors also point to improvements at aluminium producer Rusal since its merger with Sual, and at steelmaker Severstal since its IPO last year, as evidence that governance is improving.

Elsewhere, mining company Suek has created a internal audit management structure and oil group TNK-BP is introducing an anti-corruption programme.

Progress remains slow. A report this year by Standard & Poor’s found its transparency index of Russia’s 50 largest companies had risen from 50% in 2005 to only 53% in 2006.

“Corporate governance in Russia is generally becoming more transparent and more information is being disclosed, thanks to increasing pressure from international investors. Improvements in these two categories are particularly imperative for Russian companies and banks that seek more foreign listings,” said S&P.

Western investors remain wary of Russian companies coming to market and argue that changes barely scratch the surface of the problem. Vadim Kleiner, head of research at Hermitage Capital, one of Russia’s biggest foreign investors, said: “From my experience with Russian IPOs, an investor always has to ask the question of why management has chosen to sell out and go public.

“In many cases there may be something negative lurking beneath the surface that makes it a good time for these people to cash out to the public markets.”

Indeed, negative western perception of Russian corporate standards prevails. Calpers, the California state pension fund known for its focus on governance, continues to exclude Russia from its permissible equity investments, while UK manager F&C Asset Management refuses to invest in the country.

The Edelman Trust Barometer for 2007 described Russian business as the least trusted in the world because of a lack of corporate governance, lack of transparency and poor business ethics.

Investors point to the incarceration of oil tycoon Mikhail Khodorkovsky, and the final dismantling of his oil company Yukos in May, as a sign that little has changed. They also highlight how Russian tax inspectors and environmental watchdogs are squeezing western energy companies from production-sharing agreements.

A recent reminder of the bad old days is the case being undertaken by Russian investigators against Mikhail Gutseriyev, the head of Russneft, the country’s largest privately held oil company.

In echoes of the Khodorkovsky case, the interior ministry has charged Gutseriyev and his colleagues with tax evasion and illegal business activities. Reports suggest the political pressure on Gutseriyev stems from his alleged refusal to negotiate on the sale of Russneft to a state-controlled entity.

Stephen Jennings, chief executive of Renaissance Capital, claimed such incidents were rare and had not dissuaded foreign investors.

Jennings said: “Most people believe the risks are quite low. Otherwise, you wouldn’t have seen the kind of investment and development that we have seen.

"There is a definite sense that these incidents can be quarantined. If those incidents had been broader or more random, they would have had a bigger economic consequence.” Article tags:

Local investor group fights for minority rights

Financial News: Focus on Russia

Jason Corcoran
30 July 2007

The Investors Protection Association was set up in 2000 to enable investors to join forces to protect their rights and improve corporate governance in Russia.

The association, little known outside Moscow’s financial community, is the only Russian investor group that backs the rights of minority shareholders. Its membership is drawn from Russian and international banks such as Alfa, Troika Dialog, Deutsche Bank and foreign fund managers such as Hermitage, Prosperity Capital and East Capital.

Former chief executive Stanislav Vartanyan said the association had scored notable victories in the energy and fixed-line telecommunications sectors by forcing companies to pay the dividends they had promised and demanding the election of independent directors.

Members have been elected to the electricity monopoly UES and seven regional subsidiaries of state-backed telecoms group Svyazinvest.

Vartanyan said: “Russian stocks are no longer cheap because investors are paying more and more attention to corporate governance. The Russian stock market has limited capital-raising ability so companies are subject to the stringent listing requirements of London or other exchanges.”

Shareholder activism has played a role in pushing for corporate reform but arguably a minor one. Two activist hedge funds, Hermitage and Prosperity Capital, operate on a regular basis in Russia.

Swedish-owned Prosperity continues to thrive but Hermitage has suffered outflows following the barring of its crusading founder Bill Browder from Russia.

Prosperity’s modus operandi is collaborative: to support a company’s management and give it a chance to perform. However, it can become aggressive when results disappoint and has filed several lawsuits against the Russian oil company Surgutneftegaz.

Prosperity is tangling with Lukoil, another oil company, over the legality of the merger of its subsidiary NGD with Ritek, in which Prosperity is the largest shareholder.

Mattias Westman, chief executive of Prosperity, said: “Ritek is a flashback to the bad old days but things have greatly improved. The enforcement of the tax codes and the abolition of complex corporate structures has helped. We have taken a lot of board seats in the power utilities sector.”

Hermitage has been a vocal critic of state-controlled entities such as Gazprom, Sberbank and Unified Energy Systems since it began investing in Russia in 1996. But Browder’s exclusion has led Hermitage to turn to other emerging markets in Latin America and the Middle East.

Hermitage did not field a candidate for election to Gazprom’s board on June 24, nor did it release its annual report highlighting alleged shady practices at the energy giant.

Moscow-based Vadim Kleiner, research director of Hermitage, declined to comment but other investors suggested there was little value in agitating for reform at Gazprom.

Moscow roadworks: stop the traffic

A scene on the boulevard ring in Moscow.