With the Russian equity market reacting in typically high-beta fashion to the latest wave of global risk aversion, stepping back to consider piecemeal news on long-term risk factors may not seem like a priority. But the past two weeks have produced striking events in the key areas of corruption, corporate governance and the business climate, and I see two reasons for paying attention to these developments even at a time like this.
The first reason has to do with relative valuation, which at present constitutes the strongest fundamental argument for exposure to Russian equities (or, at least, the main rationale for overweight exposures). Timing, of course, is another matter – as underlined by the renewed global market turbulence. But while this turbulence has an obvious bearing on risk-adjusted returns (especially given Russian volatility), it is not relevant to the fundamental valuation-based case, which hinges instead on whether certain key risks are adequately priced. Many of these risks are linked to threats from corrupt government officials and controlling owners. It follows that whatever one’s view of the attractiveness of present valuation discounts, any serious evidence of that type of risk being reduced would be an argument for increased exposure to Russia.
Before making the individual case for each event in my selection as amounting to serious evidence of risk reduction, the first point to highlight is the feature which all three of these developments have in common – namely, that they involve practical actions. Here is the second reason why investors should take note. In contrast to mere policy declarations or legislation which may or may not be implemented, eye-catching actions reveal what is changing now.
On 30 April, Vera Trifonova, a 53-year-old business woman, died in a Moscow detention centre where she had been held awaiting trial since her arrest on fraud charges in December 2009. Sergey Pysin, the prosecutor conducting the investigation, had blocked repeated requests for bail on health grounds (Trifonova was a diabetic with kidney disease) and has now himself been charged with criminal negligence (carrying a maximum five-year jail term).
This outcome resulted from an investigation ordered by President Medvedev, who, in the same period during which Trifonova was dying in preventive custody, had initiated legislation designed precisely to prevent such outrages. The new law, which provides that people charged with “white collar” crimes should get bail, resulted from a very similar scandal (the death in November 2009 of Sergey Magnitsky, a lawyer who had been working for Hermitage Capital Management). It was enacted in April, but too late to save the unfortunate Vera Trifonova.
Amending the criminal justice code in this way is a breakthrough, but even more important is the fact that Pysin has been indicted – in contrast to those held responsible for Magnitsky’s death, who were merely sacked (as, incidentally, have been Pysin’s superiors in this latest case). The practical prospect of criminal prosecution will be more effective than any law in concentrating the minds of the law enforcement “mafia”, for which preventive detention has become one of the most widespread and damaging ways of shaking down entrepreneurs (Trifonova’s lawyer reports, plausibly, that Pysin had offered bail if she admitted guilt).
The deadline for top officials to declare publicly their income and real assets (and those of their immediate families) was 30 April. This requirement was introduced in one of Medvedev’s first anti-corruption laws, enacted in 2008, which it has taken until now to implement. The effect of this action can best be summed up in one word: glasnost.
The openness and publicity introduced by Mikhail Gorbachev in the late 1980s had the (unintended) effect of precipitating the collapse of the Soviet system. By the same token, this fresh blast of glasnost will corrode the edifice of corruption. The leading Russian newspapers have feasted on the juicier details of the wealth of senior officials who earn government salaries of around US$80,000. The significance lies not in the veracity of these declarations (most of which may be safely assumed to be incomplete), let alone the prospect of spectacular prosecutions based on the details of what has been declared. Most wealthy officials have the “alibi” of previous periods spent in private business (although there are some exceptions: Vladimir Resin, the Moscow City government official in charge of the construction sector since the early 1990s who was photographed by the Vedomosti newspaper in 2009 wearing a wristwatch worth US$1 million, attributed his officially declared income of US$700,000 to the proceeds of “publishing a textbook and patenting an invention”).
What really matters here is a newly heightened accountability or at least public exposure. Elena Baturina, the entrepreneurial wife of Moscow Mayor Yury Luzhkov, declared income in 2009 of US$1 billion. Egregious realities which have always been well known and much discussed in private or semi-private are now being given formal and regular public airings. The effect, sooner or later, will be the snapping of patience; and even if this does not mean zero tolerance, it will result at least in much-reduced tolerance.
On 27 April, the presidium of the Supreme Arbitrazh Court (SAC – Russia’s top commercial court) handed down a definitive ruling in the latest episode in a long-running corporate governance battle at Ingosstrakh (Russia’s leading insurance company). Ingosstrakh is controlled by Oleg Deripaska’s Basic Element group, but the Czech private equity firm PPF holds a 38.5 per cent stake. Under Russian company law, which provides for many direct shareholder rights, such a stake is more than enough to secure strong board representation and to block dilutive share issues.
Deripaska, for his part, has attempted to get round this “problem” in various ways. His first move against PPF was to vote a massive share issue at an EGM held in 2007 without PPF’s knowledge. The protracted ensuing legislation resolved the issue in PPF’s favour. Deripaska’s next gambit came at an EGM in December 2008 which adopted a resolution detailing procedures for the company’s board of directors. The resolution required only a simple majority, but the new procedures were designed to hobble PPF’s representatives on the board. Once again, PPF sued – and won. Deripaska appealed in ever higher courts – and lost.
His defeat is sealed by this latest SAC ruling, which has important wider implications since the SAC presidium’s decisions now enjoy the status of binding precedents to be respected by the lower courts when ruling in similar cases in the future. In a forthcoming research note, we will look in detail at this highly important development as well as at the practical impact of the SAC as the champion of property rights and defender of business.
With best regards,
Christopher Granville
Director, Russia & FSU Research
