Shamil Magomedov is editor-in-chief of the Russian version of Families in Business. He lives in Moscow
Melanie stern is section editor of Families in Business
As the need for outside investment slowly erodes a corrupt regulatory environment and the shackles of state control, Shamil Magomedov and Melanie Stern find foreign private banks looking to Russia to tap into the burgeoning family business sector
It's a good sign: News Corporation patriarch Rupert Murdoch is in talks with Russian steel-to-television conglomerate Severstal, founded by husband and wife Irena and Dmitry Lesnevsky, about the possibility of taking a stake in its Ren TV arm. Any such move would mark Murdoch's most concerted commitment to the country yet – and undoubtedly set an investment trend. Moreover, it could herald the beginning of the end for state-controlled media (Ren is already considered one of the most independent).
Even after the financial meltdown of the Russian banking system in 1998, in which millions lost their life savings amid the collapse of the rouble, foreign investment in Russia has been held back by a complex, corrupt, aged and badly-managed infrastructure, kept in a state of ineffectiveness by a problematic relationship between commerce and state.
A series of such high-profile financial and banking crises in the past decade have not only exposed the yawning gap in the domestic market for transparent and well-run services, but have also given private banks in Europe ideas about where their next emerging market is. Thirdly – and crucially – there is plenty of strong evidence to show that Russia is home to a burgeoning class of super-wealthy business families who have not had a professionalised private banking advisory market to take their money to.
There are at least 84,000 individual dollar millionaires in Russia, according to the Merrill Lynch/Cap Gemini 2004 World Wealth Report, and this is expected to double by 2010; the nouveau riche or 'top middle class' in Russia makes up less than 5% of the country's adult population, but this small percentage has been more than enough to attract considerable investments from foreign private banks, including Credit Suisse First Boston, Citibank, Reiffeisen bank and European bank for Reconstruction and Development.
Families in Russia are as politically powerful there as American or European dynasties are in their respective regions, and they are astute enough to want the sophisticated investment and money management solutions on offer elsewhere. They can secure these if they take their accounts offshore – but as markets open up, families await their chance to keep their money at home and allow it to fuel the maturity of their home country. These elements combined, it was only a matter of time before the domestic private banking market opened up.
Although they are now major players in the market, most foreign players in Russia are not highly visible, preferring not to seem as if they have undue influence or stature over the domestic banking system as the sector remains exposed to ongoing political and economic fragilities.
There is also a clutch of domestic players like MDM-bank, MMB, Zenit, NIKoil Financial Corporation, CentroCredit and Derzhava serving wealthy business families under a 'club', or elite service, though many of these are still tied up with state interests in either a direct or indirect way, and will continue struggling to escape federal control. The quality of these players is not assured; last year a credit crisis among Russia's private banks saw some key players, including Guta Bank sold off, while Alfa Bank – another important private banking institution – allegedly faced a liquidity meltdown.
GLOBEXBANK is one of the top ten banks in the Russian Federation, though it remains state-controlled; Rosbank is owned by domestic conglomerate Interros Group, one of the country's largest private investment companies, which produces 1.3% of Russia's GDP. Clients know that domestic banks will have a hard time matching their international competition because, while western banks coming to Russia must register themselves under domestic legislation and take on all the risks inherent in such a fluid, nascent economy, Russian banks are now expected to match western standards of governance and transparency; only few are capable of this because it requires huge investment in technical systems and staffing.
Wealthy families seeking suitable money managers may look to players that have business outside of Russia – domestic or foreign – as they can perhaps account more accurately for their internal processes and financial strength if they must play to international regulation. However, these players may commonly be the state-owned ones. Additionally, Russian families are much like those anywhere else in that, so long as they own their companies outright (a phenomenon that has only been seen in earnest in the last decade), they usually prefer to keep their account protected and totally confidential from the claws of the state.
Business families in Russia have many of the hallmarks of their western counterparts, but the striking difference an often un-sophisticated approach to their organisation and management towards optimising wealth. A typical portfolio in this case usually includes all the stock in their companies in a holding structure, organised to funnel the dividends directly to the family and access to short-term cash. Attached to this is the family's basic banking needs – a checking account, cards and so on. Families usually run a stock portfolio, but it is not well diversified into alternative investment vehicles and is risk-averse. It may also include the family's property, and some keep their art or wine collections with their financial investments, although they do not keep these as diversification tools, but simply as hobbies – they are not maximised on.
Big businesses, many of them family-owned, were created on the wave of privatisation in the 1980s and 1990s. These businesses have stored assets both inside and outside Russia, with one part being kept specifically for use in the business, and the other is used by the family for living expenses. Memories of the 1998 crisis are still at the forefront of many people's minds, and they don't take risks with what is considered the family livelihood – so investment through domestic structures is not a common choice for wealthy families.
The behaviour of this segment of the investor community has been thoroughly studied and is deemed easy to predict – most families will be more active in using their money to plough back into their businesses, and will not make their personal finds work hard. This is because knowledge about how to do this is low – so foreign private banks see an ideal opportunity to enter a market almost at inception and be the educators of a niche that will later, predictably, become customers. Moreover, long-term loyalty from these clients can be easily formed, through expanding the range of services provided to them.
Succession is another big issue that Russian families are beginning to consider, and one that private banks in Europe are well used to servicing for a fee. Although many family businesses in Russia are first generation (but not necessarily small- and medium-sized enterprises), their attitude to family members working in the company is in stark contrast to western families. They have long believed that there should be no assumption a family member will be given a job in the business, and indeed that it is far better to hire external managers.
While this seems a quite paradoxical governance bubble in the context of endemic corruption, Russian families are moving fast to become more like western families in the way they grow their businesses and manage their wealth – and the idea of family succession is more commonplace with it. Since wealthy Russians place a great amount of importance in education, successors and children are usually educated at the USA's Ivy League or Europe's most distinguished universities; they are encouraged to gain work experience, and then they are ready to discuss taking on the family business mantle.
Much is expected of them in preserving the success of the family in elevating itself above the common poverty and strife Russia is well used to, and so these successors are often bright, highly capable and ambitious people. As most private banks make much of their succession offerings, this is another key market ripe for development, while Russia's successors, fresh from the world's best educational institutions and fuelled by second-generation thirst for success, will likely kick both domestic and foreign private banks into touch.