This year bears all the hallmarks of a terrible year for investors in Russia. The international community has been stunned by Russian President Vladimir V. Putin's brazen moves to concentrate authority in the executive branch and dismantle Yukos, one of the country's best-managed private oil companies. That has sparked widespread concern that the Kremlin is shifting into reverse in the drive for economic reform. Foreign investment-bank executives are indeed packing their bags. But rather than jumping on the next flight home, they're lining up for the next flight to Moscow. "The markets that investment banks are typically focused on -- advisory, equity, and debt -- are very promising and these services are in demand in Russia at the moment," says Kevin Hudson, head of the European emerging-markets group at Credit Suisse First Boston in London.
In 2004 alone, hardly a month has gone by without one of the big international banks announcing a major expansion in Russia. Deutsche Bank (DB) started the ball rolling in January, buying 40% of United Financial Group, a leading local investment bank, for an estimated $70 million. Citigroup followed in July with plans to launch an equity trading operation in Russia, while Morgan Stanley applied for licenses to trade bonds, stocks, and currencies locally -- the first stage of a $30 million expansion. Then, in late August, UBS announced it would boost its stake in local investment bank Brunswick UBS from 50% to 100%. "You have global ambitions if you're a global investment bank, and Russia is too big to ignore," says David Walker, a UBS spokesman.
Russia isn't exactly virgin territory, of course. Big U.S. banks like Morgan Stanley and Goldman, Sachs (GS) opened offices in Moscow in the 1990s. But the bankers generally kept their operations small and focused on advisory services for a small number of large companies. Now, though, they have decided the time is right for a major financial commitment. Why the offensive? In part, banks are following their clients, who have been lured by high returns on Russian equities in recent years: Russia's stock market has shot up 300% in the past three years and is up 15% over the last year despite the jitters about Yukos' fate. That has generated a lot of investment from mutual funds focused on the global oil and gas industry. "A lot of these funds have delivered strong performance in recent years because of investment in Russia," says Stuart Harley, who is setting up Citigroup's Russian equities unit. A second attraction for Citigroup, he says, is the growing demand from local Russian portfolio investors -- a market segment still in its infancy but growing fast. According to Alfa Capital, total private investment has now reached $9 billion, up from just $3.5 billion last year, the bulk of it invested by pension funds and private investment funds.
Securities trading also provides a back-door entrée into corporate finance, the traditional focus for investment banks in Russia. Rair Simonyan, managing director of Morgan Stanley in Moscow, says that by extending his bank's range of products to include securities, he hopes to gain a competitive edge in the expanding market for advisory services. "We felt that if we can't deliver a broad menu of products, we can't provide the service the clients expect," he says.
There's ever more corporate finance work to go round. "The real attraction is the scale of the place. The companies are really big, and big consumers of capital," says Charles Ryan, chief executive of United Financial Group. Corporate eurobond issuance will hit $7.6 billion this year, and share issues -- once a rarity -- are coming into vogue. Chelyabinsk-based Mechel, a steel producer, is set to debut in an initial public offering worth an estimated $250 million on the New York Stock Exchange this month. Several other companies, including telecom holding company Sistema and TV company Storyfirst Communications, are looking at stock exchange listings. M&A is also taking off, driven in part by a revival in foreign direct investment. September alone saw two cross-border deals: the $1.9 billion acquisition of a 7.59% stake in oil firm Lukoil by U.S. oil major ConocoPhillips (COP), and the $1 billion acquisition of 25% of Novatek, a Russian gas producer, by France's Total (TOT). "A substantial and longstanding local Russian presence is absolutely crucial," says Hudson from CSFB, which advised on the Conoco/Lukoil deal along with Citigroup. "The decisions on who advises are based on relationships that have existed for years."
In fact, with so many investment banks flocking to Russia, the biggest complaint is the growing competition, which has pushed down fees. But the competition also explains why banks are so keen to expand into high-margin new segments of the Russian market. For example, both Morgan Stanley and UBS are emphasizing derivatives -- a product that has been almost completely unknown in Russia.
And the Yukos affair? Bankers admit that the Kremlin's attack on the oil giant has damaged investor sentiment. But they point to Russia's strong economic growth -- set to hit 7% this year -- and the obvious long-term improvements. "If in 1998 or 1999 you had predicted the positive situation you have now, everyone would have questioned your sanity," says Harley. As long as Russia's economy keeps on ticking -- and the deals keep on clicking -- investment bankers will be more than happy to shrug off this year's unpleasant surprises.
By Jason Bush in Moscow