Friday, 17 August 2018

Growing pains

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International investment banks are falling over themselves to commit resources to Russia, identifying it as a key source of revenue for the future, especially as many other markets falter. Inevitably, as more US and European banks enter the market and increase their headcount in Russia, their own cultures will begin to permeate the country, but to what extent? Solomon Teague reports.

To many market professionals, especially those in Russia, the country has moved a significant distance down the path of convergence with the West in terms of business.

“Russia has become increasingly integrated into the world economy,” said Steven Fisher, corporate bank head of Russia and CIS at Citi in Moscow. And it continues to move in the right direction, he said. “International accounting standards, transparency and corporate governance continue to become more prevalent.”

Others agree. “From an empirical standpoint, since 1992 when Russia opened up, it has gradually orientated itself more towards the market and aligned itself more to the west. It is closer to the Anglo-Saxon world – even in oil and gas,” said Pavel Malyi, UBS’s head of investment banking for Russia, Ukraine and Kazakhstan.

“The way business is done here is moving in the same direction. More young people are driven by entrepreneurialism than ever before. Management here act in the same way as they do anywhere else in the world.”

And according to Brian Lazell, head of the debt product group at Renaissance Capital, Russia is leaving behind the stigma outsiders associate with it. In any case, he thinks it has always been misunderstood.

For example, the problem foreigners most commonly identify in Russia is the question of the rule of law – or lack of it. To some extent this is a hangover from the 1990s and the problem has not been entirely resolved.

“It is perhaps an issue but the same is true in China and India,” said Lazell. “The corruption is nothing like it was in the 90s and the number of IPOs you see of Russian companies in London and New York must be seen as a vote of confidence from the capital markets,” said one Moscow-based banker.

Stephen Cohen, managing director of asset management at Troika Dialog UK said he expects Russian corporate governance standards to have fully converged with Western European markets within 10 years. It is vital it does achieve this goal if the country is to fulfil its potential, he said, although for investors it is not such a problem as companies that are well known to have problems in this area tend to trade at a discount because of it.

More companies are now issuing stock options to management as part of their remuneration packages to ensure their interests are aligned with the companies they serve, Cohen said.

“Consider the size of the country, its population, its GDP, its foreign exchange reserves and its ratings history – it has been upgraded regularly since 1998 – and, dependence on commodities notwithstanding, people should certainly be investing here,” said Lazell. He conceded that inflation remains a serious problem – perhaps the biggest facing the country today – but even in this “it is light-years ahead of the other BRIC countries.”

The notion that Russia is moving towards a “Western” model of business also presumes there is a single business culture prevailing in the “developed” markets, an assumption rejected by Dmitry Snesar, co-head of global banking for Deutsche Bank in Russia.

“In the US, Australia and the UK the culture is different – it is just the language that is the same,” he said. For example, the US is more closed to foreign investors than the UK – meaning it is probably closer to where Russia is heading. “Russia will also be different, but not dramatically so – just as those countries are different from each other.”

Western hypocrisy

Many in Russia balk at what they see as more than a whiff of hypocrisy in the way it is preached at by the west – witness the global condemnation of its move to nationalise strategically important assets, in contrast with US reluctance to allow investors from certain countries to access its own sensitive industries.

“You haven’t seen the types of problems that affected Societe Generale or other problems in Russia,” Snesar said. “Russians can copy and paste the beneficial bits they find in the global system, but there is no reason they can’t find their own way.” Italy and France also reconcile significant state intervention with an acceptable face of liberal capitalism without drawing the same criticisms, he added.

Relatively speaking, Russia – sitting in its strategically unique vantage point between Asia and Europe – is closer to the West than it is to China, Snesar insisted. Although communism was only one generation ago, already memories of it have faded, as younger Russians, with no experience under the communist system, make up an increasing proportion of the workforce. Many have worked for Western companies (like Deutsche Bank) he said.

Functions such as investor or public relations and financial budgeting are now typically conducted according to internationally accepted norms. “Russians want to comply with things like IFRS,” Snesar said, especially the larger and medium sized companies, which are – or want to be – rated by rating agencies.

Russian companies are increasingly inviting Western auditors to come and look at their books in a bid to show the world they can adhere to international norms, added James Cook of Aurora Russia, an AIM-listed private equity firm.

Russia’s economy grew 7.8% last year, and Snesar predicted it would continue at that approximate rate for at least five years – a claim he believes is shared by most analysts covering the country. “Only 50% this growth is driven by the price of oil,” he said. “The rest is thanks to internal demand, upgrades of fixed assets, construction and improving infrastructure.”

Certainly Russia appears to be at a vital stage in its development: “In the early stages it was enough just to be in the right commodities,” said Fisher. “In the longer term it is more important to ensure these things – better efficiency, productivity and corporate governance – as Russian companies face global competition. Most companies in Russia understand this perfectly well.”

The experience of the Russian airline industry serves as a good example. It practically collapsed in the face of high gas prices, with old, Soviet aircraft, such as the Tupolev 134s and 154s, medium range aircraft, struggling to compete with Western models. This has forced the development of new models like Tupolev 204 which can compete with some models produced by Boeing and Airbus.

“Russia has a policy of supporting growth in industries it can develop internally, but selectively allows waivers of importation duties for some aircraft that can’t be produced here,” said Fisher.

The businesses of the larger domestic banks are maturing to reflect more closely what could be found in an American or European bank. At Renaissance Capital, for example, there has been an increasing drive to diversify the business and to avoid any over-reliance on fee income or risk-taking business – for example the trading of FX or roubles.

This process took hold about two years ago, according to Lazell. The firm started diversifying its business and its clientele as a matter of priority, away from its traditional businesses of rouble bond underwriting and trading, into areas like Middle Eastern distribution and structured credit and derivatives.

Freedom or growth?

Yet there remains an interesting interplay between three factors in Russia: politics; the economy; and corruption, said one Moscow-based banker. “In almost every instance you can examine the relative weighting of each factor in determining the outcome. It is worrying but unfortunately corruption and inefficiency are still albatrosses in Russia.”

Confidence in Russian courts is low and any business that can be conducted offshore is being done there, according to one lawyer based in Moscow. The higher echelons of the legal establishment offer a better chance of a sensible judgement, though it cannot be taken for granted that a decision will be acted on by a bailiff.

“The problem is Russia has no tradition of independent courts,” said the lawyer. “Judges have received some salary increases in recent years but essentially they remain underpaid bureaucrats.”

Many bankers operating inside Russia wave aside questions of political freedom, dismissing their importance within the context of the financial markets.

“A decade ago Russia had US$7bn in FX reserves compared with several hundred billion dollars in foreign debt,” said Bob Foresman, deputy chairman of Renaissance Capital. “Now the sovereign has minimal debt and hard currency reserves – including the Stabalisation Fund – worth over half a trillion dollars.” He nevertheless acknowledged the role that commodities prices have played in this transition.

“In retrospect, [the crisis in] 1998 was one of the best things to happen to this country,” said Aurora Russia’s Cook. “It shook out the asset stripping and speculation.” One western businessman who bought into Russia said the perception that Russia is overrun with gangsters is good for those already here because it staves off competition from foreign companies still sitting on the sidelines.

There are three things the markets love, Foresman said: political stability; economic growth; and western-style democracy with a free press. “But if the markets have to choose two of the three, it is the first two by a distance. Just look at China,” he said.

Besides, he added, there are no restrictions on internet use, for example, and there are very critical print and radio media. The most serious restrictions on the press are in national television broadcasting.

What is certain is that Russia’s modus operandi undermined its growing global importance. “Russia could be the largest centre in Europe outside London – not just for UBS but in general,” said Malyi. The Russian market is growing faster than any in Europe and is the fourth largest in the continent, he said, behind the UK, France and Germany – and well above markets like Italy and Spain.

“It is pointless to think about the country in terms of quarters – you need to think in terms of a decade,” added Malyi. “The country is experiencing a fundamental shift as it catches up with Western markets. It will take a long time, though it is quicker in a more benign environment.”

It has been argued that Russia has a cultural preponderance towards equities, and its growing stature in the global equities market is helping make the business community more transparent.

“Russia is an equity risk environment, so it is better to offer equity products with equity returns,” said Malyi. He also said Russian entrepreneurs have traditionally had a greater awareness of the equity markets than in many other markets because banks have played less of a financial intermediation role than they have elsewhere.

There has been a swelling interest in IPOs across all sectors, in spite of the problems that were triggered by US sub-prime mortgages. Before the credit crisis, Russia was seeing bond issuance on a weekly basis, a frequency that has fallen closer to one deal per month now. Yet despite the relative appeal of equity issuance now, the crisis has taken its toll on this sector too.

Regardless of the timing, the lure of the equity markets has, on the whole, had a positive impact on corporate governance issues in Russia, said Malyi. “If you can go public it provides an incentive to clean up things like disclosure,” he explained.

“Banks respond to their clients’ demands. Clients want good quality companies with credible management, so that is what the banks look for.” It is another incentive for corporates to adhere to Western definitions of good corporate governance, as they will find it easier to get access to the banks at attractive levels.

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