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Russia & CIS Express A look at key issues and trends

Our Russia & CIS Business Group discuss business opportunities, what’s happening in some key sectors, and economic and political developments. Spring 2011 In this issue:

Inside Cover From our Editor

Page 2 Russia and the other BRICs

Page 4 Growth soars in Mongolia’s From our Editor banking sector

Page 7 When is a Door Not a Door? The sheer scale of demand is Welcome enormous, with a number of high- Page 10 Following a challenging past year, profile private investments already The land of opportunity when drought and heat-wave improved. These include multiple – Russia’s surging demand for slowed down economic activity, PPPs and concessions in the St new infrastructure investment Russia’s growth trajectory is firmly Petersburg and Moscow regions, back on track. And with inflation Page 14 from the Western High-Speed predicted to recede in the second The view from the hustings Diameter, the Orlovsky Tunnel and half of 2011, the climate for the Nadex light rail project. The Page 15 investment looks increasingly utilities sectors are seeing even Sochi 2014 attractive. more activity and government support for technology and Page 17 This macro backdrop aligns innovation is another high-priority Taking the long-term view favourably with government plans area. to privatise several state-owned Page 18 enterprises through to 2013. And Looking ahead, Russia’s host role in Russia’s banks back on the with a raft of business-friendly two major sporting events – the investment radar reforms scheduled – including the 2014 Olympic and Paralympic abolition of capital gains tax on Winter Games and the 2018 World Page 22 long-term investments from 2011 – Cup – can only boost demand for Belarus – prospects for growth? there are real causes for optimism. foreign investor participation.

In this issue of PwC’s1 Russia and As we report in this issue, CIS Express, we showcase some of preparations for the Sochi 2014 the opportunities now coming on Games are already well underway, stream. Russia’s surging demand with a massive programme of for new infrastructure investment development ongoing in Russia’s is a case in point. Since President Caucasian Black Sea region. Besides Putin’s 2007 announcement that funding a new, state-of-the-art US$1 trillion would be needed to national winter sports centre, the modernise the country’s US$9.7 billion investment is set to infrastructure over the next 10 transform the local and regional years, all levels of government are infrastructures, turning the focusing on fostering the right surrounding Krasnodar district into environment for private a year-round tourism destination investment. supported by new air, road and rail links, alongside upgraded utility projects and 21st century communications.

1. In this document, “PwC” refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom), which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. Crucially too, the Sochi 2014 foreign buyers to fund future ‘journey’ will continue long after the growth. Games have concluded. By ensuring compliance with rigorous local, Further afield, we report on surging national and international growth in Mongolia’s economy – environmental regulation, a core and, specifically, the opportunities priority is safeguarding the region’s that this is creating for rapid ecosystem and setting a new expansion in the domestic financial standard for environmentally sector. As the country’s mining efficient construction throughout boom gathers pace, some observers Russia. At a grass-roots level, Sochi’s believe that it has the natural Nick Page sporting infrastructure should resources and economic potential to Editor deliver lasting benefits to future become the ‘new Qatar’. [email protected] generations. To take just one Commercial bank assets have example, the new Russia doubled in the past three years and, International Olympic University, as the country’s vast mineral being built in Sochi, will produce a potential is further exploited, huge new generation of sports managers, demand is predicted in both satisfying demand in Russia and corporate lending and retail worldwide for highly-qualified business. specialists in event management. The recent strategic partnership The ambition driving progress to announced between the London Sochi 2014 and the World Cup looks Stock Exchange and the relatively set to redefine the art of the possible under-developed Mongolian Stock in international event management. Exchange should provide a welcome And with the eyes of the world boost to the financial infrastructure, trained on Russia, there is every putting in place a firm foundation incentive to ensure world-class for IPOs, dual listings and strategic performance at every level. That partnerships with international said, Russia (and the CIS) continue investors. And with ING one of only to demand a long-term view from a few international banking groups foreign investors, as Sir John on the ground, the potential for Stuttard, co-chair of the Kazakh- significant competitive advantage is British Trade & Industry Council, there for other early movers, explains later in this edition. provided they are prepared to put down roots in the country. This is especially true of Russia’s financial sector, where more needs Of course, the song remains the to be done to improve the quality of same in some ways. Financial sector underlying contract law and reforms are urgently needed to regulation. That said, investor strengthen governance, interest in Russia’s banks is transparency and capital adequacy. definitely on the increase. Although But provided these are forthcoming, the sector has bounced emphatically there is every indication that this since the financial crisis, recording a country – long off the map for most combined net profit for 2010 of foreign investors – will start to be around US$20 billion, multiples seen as a sustainable engine for remain relatively low and many future growth across the region. local banks, particularly in the mid-tier segment, are keen to attract

Spring 2011 1 While the breakdown of growth in Q3 2010 is not yet available at the time of writing, the Q2 2010 growth indicates domestic demand has been driving output (see Chart 1). Exports showed very weak growth compared to the spectacular growth recorded in the year to the first Russia and the other quarter. At the same time imports surged, shrinking the current account surplus from US$33.3bn in BRICs: first among equals Q1 to US$18.7bn in Q2 2010.

The Central Bank might hike interest rate further In response to these economic developments, the Russian Each quarter, PwC’s Macroconsulting team produces an in-depth Economic Government took measures such as View report focused on the fast-growing BRIC economies (Brazil, Russia, the banning of grain exports in India and China). These reports can be downloaded at www.pwc.co.uk/ August 2010. However inflation economy continued to accelerate, rising from 6.1% in August to 8% in November Here is a summary of some of the highlights from the latest edition, focusing 2010 on account of rising food particularly on the analysis on Russia. prices. In December 2010 the central bank took the first step away from the loose monetary policy implemented after the financial BRICs: the current state of Russia: domestic demand crisis, by raising the deposit rates by play—an overview comes to the fore 25 basis points taking them to Overall, the BRIC economies have Russia’s fast-paced economic growth 2.75%, but left the benchmark managed to navigate the financial lost steam in Q3 2010 with the refinancing rate unchanged. crisis and global recession relatively economy growing at half the pace well. Brazil, India and China seen in Q2. The slowdown of growth Further rate hikes are expected in registered strong growth in 2010, in Q3 2010 was widely expected on the first half of 2011 if inflation although Russia’s growth rate account of the failed harvest and continues to remain high. With the lagged behind as drought and a heat heat wave. wave slowed down the pace of economic activity and triggered an acceleration in inflation. However, Russia’s growth is now catching up Chart 1: GDP forecasts for BRIC economies strongly with the other BRICs as its economy rebounds (see Chart 1). Brazil Russia India China

On account of economic expansion 10% and rising food prices in the BRIC countries, their headline inflation rates rose above their official central 5% bank targets in 2010. A potential easing in inflationary pressures is 0% expected as policy-makers resort to fiscal and monetary tightening. This -5% could facilitate growth at more sustainable rates in 2012 following the strong recovery in 2010 and -10% slight moderation in 2011. 2009 2010e 2011f 2012f

Source: Economic views BRIC, PwC January 2011

2 Russia & CIS Express likelihood of the export ban on reforms announced earlier, such as Another factor that might slow wheat being extended until the end the abolition of capital gains tax on down economic growth is the of this year and ongoing monetary long term investments from 2011 slowing of export growth tightening, headline inflation should and the reduction of foreign accompanied by rising import ease off in the second half of next investment restrictions. Fuelled by growth. According to latest balance year to average around 6.7% in 2011 strong domestic demand, we expect of payments data, the current and 7.1% in 2012. Russia to grow at 4.3% in 2011 and account surplus has been shrinking 4.8% in 2012. through last year, reaching US$8.7bn in Q3 2010, down from Government policies to US$33.3bn in Q1 2010. If this trend support investment in 2011- Risks to growth continues, the contribution of net 2013 Although we expect the Russian exports to the overall growth could Going forward, we expect the spike economy to grow strongly this year turn negative this year. in inflation to hurt private there are certain risks around our consumption, which has been one of forecast. If inflation continues to the main drivers of growth. We accelerate, Russia might face a estimate 3.9% growth in 2010, and longer than expected period of that monthly year-on-year inflation monetary tightening this year. rose to 8.4% in December. Inflation is expected to start to gradually recede in the second half of this year, resulting in interest rates stabilising and a more favourable climate for investments. This Spotlight: Russia to host contributes to stronger economic 2018 World Cup growth expectations over the next two years. The BRIC countries have recently hosted or are set to host a number of major sporting events — a trend At the same time, recent-announced that partly symbolises their increasingly established government plans to partly position and role in the global economy. Russia won privatise several state owned the rights to host the 2018 World Cup and is already enterprises during 2011 and 2013 in an advanced state of preparations for the Sochi are likely to strengthen investment Winter Olympics in 2014 (read our article about this growth and could attract more on page 15). foreign investment. This aligns well In combination, the hosting of these two events will with the other business-friendly provide a huge investment boost over the next eight years. For Russia, FIFA’s decision may speed infrastructure development as the government prepares to spend around US$9.6bn on stadiums and expand both airports and roads. Russia’s bid for Chart 2: Russian year-on-year growth rates the World Cup includes construction of 13 stadiums and renovation of three more stadiums. These huge GDP Consumers Gov Investment Exports Imports infrastructure plans could cause government borrowing to surge to 15% of GDP from 11% over 20% the next three to four years. However, the programme will also encourage 10% public-private partnerships and attract more foreign direct investment, which could help limit

0% government borrowing. Companies in the construction business, steelmakers, and transportation companies are likely to gain from an -10% expected rise in infrastructure spending. Russia’s airline and media companies could also see a boost. -20%

2009 Q4 2010 Q`1 2010 Q2 2010 Q3

Source: Economic views BRIC, PwC January 2011

Spring 2011 3 the IMF has described as a ‘dramatic Recent discussions with senior turnaround’ and is set to grow by an executives from a number of estimated 7% in 2011. By 2015, the Mongolian banks have revealed IMF believes that growth will reach renewed optimism within the 13%, outstripping its neighbour and sector. ‘The sector has recovered main trading partner, China1. well from the downturn of 2009. Our own bank had a record year of profitability in 2010,’ said Simon Landmark deal Growth Morris of Khan Bank. As personal Mongolia has always been a incomes increase, Mr Morris is significant exporter of raw looking ahead to rapid growth in soars in materials, benefiting from its Khan Bank’s retail business. strategic position between Russia Corporate business is also Mongolia’s and China. However, Mongolia’s expanding. ‘SME business is vast mineral potential has remained growing. The anticipated increase in banking relatively under-exploited. The IPO activity also offers significant signing of the Oyu Tolgoi mining opportunities. While we don’t yet agreement in 2009 and the surge in have the balance sheet size to sector investment from international transact the large ticket mining mining groups it heralds have deals on our own, we could be in a therefore opened up a new chapter position to carry out such deals in in Mongolia’s economic the next few years as our scale and development. capabilities increase,’ said Mr Morris. ‘While there are huge The Oyu Tolgoi site contains what is opportunities in this market, we’re Mongolia’s banking sector is believed to be the world’s largest conscious of the need to concentrate undergoing exponential growth as untapped copper deposit, along with on our core strategy and grow at a the country’s mining boom gathers abundant supplies of gold and sustainable rate, rather than pace. Yet, this rapid rate of growth silver2. The project is a joint venture running the risk of spreading in the sector presents inherent between Ivanhoe Mines, Rio Tinto ourselves too thinly.’ challenges and risks. How are the and the Mongolian government and country’s banking leaders looking to is due to begin commercial ‘One per cent of GDP growth balance the challenges and production in 2013. Once the mine translates into 6% growth in opportunities? reaches full capacity in 2018, it will banking sector assets,’ said John provide around 3% of global copper Finigan of Golomt Bank. ‘With Mongolia is at a watershed as its supplies and account for nearly a growth in the economy accelerating, huge mineral resources are opened third of Mongolia’s GDP3. With the potential for our bank and the up to development by international Mongolia already supplying around sector as a whole is clear.’ Golomt firms. Simon Morris, CEO of Khan 40% of China’s coal imports, the Bank’s assets grew by more than Bank, Mongolia’s second largest planned multi-billion dollar 40% in 2009 and 2010. Mr Finigan bank by assets, describes this as a investment in the giant Tavan Tolgoi sees considerable further potential ‘time of transformation’ for the coal mine will provide a further in both corporate lending and retail country and its banking sector. John boost for economic growth4. business, including debit and credit Finigan, Chief Executive of Golomt cards. Golomt Bank has also Bank, the country’s largest bank, recently set up a specialist believes that Mongolia has the Banking growth investment banking division. natural resources and economic The expansion of Mongolia’s potential to become the ‘new Qatar’. banking sector mirrors the growth ‘Our assets have grown nearly in the economy as a whole. Banking eight-fold in the past five years. We Two years ago, Mongolia was in penetration is still low in what anticipate at least that rate of recession as it grappled with a remains a predominantly cash growth over the next five years,’ said combination of the global financial economy, though expansion in the Bold Magvan, Chief Executive of crisis, an exceptionally harsh winter sector is gathering pace. Commercial XacBank, Mongolia’s fourth largest and the collapse in the prices of coal bank assets have doubled in the past bank. SME lending and housing and copper, its main exports. Since three years. Loan volumes increased loans are now growing faster than then, the country has staged what by 19% in 20105. XacBank’s traditional microfinance business. As XacBank looks to bring 1. IMF Mongolia Update, 13.09.10 and IMF World Economic Outlook, October 2010 2. Ivanhoe Mines Oyu Tolgoi Overview, 10.03.11 its services to some of the more 3. Wall Street Journal, 08.06.11 4. Coal Investing News, 13.11.10 5. Bank of Mongolia

4 Russia & CIS Express Mongolian banking at a glance

• Assets of just under $5 billion • 14 commercial banks • Upper end of market is highly concentrated, with top four banks accounting for more than 75% of deposits and lending • Deposits of $3.6 billion • Loan volumes of $2.6 billion • Non-performing loans as a proportion of total loans of 12% (Figures 31.12.10) Zaisan Tolgoi Monument for Soviet Military Source: Bank of Mongolia in Ulaanbaatar Picture caption

remote regions of the country, it has Risks and challenges revenues could be used to develop launched a new mobile phone and diversify the economy. As with any rapidly growing and banking service, which is delivered increasingly resource-based in partnership with local operators Rapid growth also presents economy, there are risks. These and agents. governance and risk management include vulnerability to commodity challenges for the banking sector. price movements and any dip in Randolph Koppa, President of the These were highlighted in 2008 and Mongolia’s main export markets, Trade & Development Bank (TDB), 2009 when two of Mongolia’s banks China and Russia. The government Mongolia’s third largest bank, is collapsed. Bad debts also rose in the is mindful of these risks. This equally upbeat about his bank’s sector as a whole, reaching a high of includes strengthening ties with prospects. TDB’s assets grew by 17% of total loans in September Western countries as part of a ‘third nearly 70% in 2010. ‘As growth in 2009, though they had fallen back to neighbour’ policy, which seeks to mining accelerates, we’re seeing 12% by the end of 20106. avoid over-reliance on China and significant expansion in demand for Russia. lending to industry suppliers The Mongolian government including equipment and haulage responded with a bank Mining expansion may also drown firms. We’re also seeing strong restructuring programme, which out growth in other parts of the growth in demand for trade finance seeks to strengthen governance, economy. ‘It is easier to get including remittances and letters of transparency and capital adequacy7. investment to dig the coal than fund credit,’ he said. ‘The potential for The government has also enacted a the infrastructure improvements further growth is evident. At less deposit guarantee scheme, which needed to ship it more efficiently than 40%, the loan to GDP ratio is helped to boost deposit levels by and support development in the still quite low by emerging market more than 50% in 20108. wider economy,’ said Randolph standards. The ratio will need to Koppa of the TDB. Chile, another grow by 40-50% a year to meet The banking leaders we spoke to all leading copper exporter, has been increasing demand,’ he continued. underlined the importance of strong cited by the government as a governance, disciplined reporting possible model for how mineral and introducing international audit

6. Bank of Mongolia/Business Monitor International November 2010 7. Mongolia Monthly Economic Update, March 2010 8. Bank of Mongolia and lending procedures in listing on international exchanges growth in the economy continues to strengthening client trust and and strategic partnerships with accelerate. The capital required to sustaining the stability of their international investors. IPOs are the establish an operation is relatively sector. In 2009, the Mongolian main topic for any gathering of modest (circa $6 million). However, Bankers Association established a Mongolian business leaders as groups seek to develop and Credit Information Bureau (CIB), of following the successful listing of strengthen their presence, being which Bold Magvan of XacBank is the Mongolian Mining Company in able to demonstrate a long-term the Chairman. In September 2010, October 2010 and the potential commitment to the country and a the CIB agreed to set up a joint listing of the Tavan Tolgoi mine in readiness to provide opportunities venture with Dun & Bradstreet to the course of the next year. The for local people will be vital in provide consumer and commercial question no longer seems to be ‘if’ attracting business, talent and credit information services in the but rather ‘when and where’. Until government backing. Mongolian market9. recently, Hong Kong was the preferred location. However, the Preparing for lift-off PwC Mongolia formed in 2010, and LSE deal with the MSE may well as such is the first professional have changed the game, creating Mongolia is on the verge of services firm to have partners and opportunities to develop the economic transformation, which staff at all levels permanently in domestic capital market and will in turn lead to a huge increase Mongolia. PwC Mongolia now has a bringing with it the potential option in demand for lending and banking team of over 30 people in the of a dual listing in London and services. As the country’s banking country bringing audit, accounting, Ulaanbaatar. leaders recognise, strengthening tax, process improvement and governance, transparency and risk capital markets expertise. In a Mongolia’s banks also face the management will be crucial in further boost to the financial challenge of competing with the creating a sustainable platform for infrastructure, the London Stock mining sector for talent. ‘We need to long-term growth. Exchange (LSE) has just entered be able to offer young graduates a into a strategic partnership to help long-term vision for our future and Mongolia’s banking sector offers support the expansion and their career development prospects significant and still largely untapped modernisation of the small and within this,’ said Bold Magvan of opportunities for international relatively under-developed XacBank. groups. Early movers will gain a Mongolian Stock Exchange (MSE)10. significant advantage, though International banking groups have groups will need to be prepared to Further challenges include raising limited presence on the ground in put down roots in the country to sufficient capital to support growth Mongolia – ING is one of only a few realise the full potential. in the sector. This is likely to open to have set up a representative office the way for possible IPOs, dual – though this is likely to change as

Sebastian Merriman Jelena Pesic Tax Leader, Senior Manager, Assurance, PwC Mongolia PwC Mongolia

[email protected] [email protected]

Sebastian Merriman leads the Tax Jelena is a Senior Manager in PwC team in PwC Mongolia. He is Mongolia’s Assurance team and has currently on secondment to the almost eight years’ experience in region from PwC UK office, and providing audit services to banks worked in Kazakhstan for a year and and other financial institutions. a half before relocating to Mongolia She relocated from PwC to set up the new office in Kazakhstan to PwC Mongolia in Ulaanbaatar in summer 2010. September 2010 and was active in Sebastian advises a range of establishing the office in international mining and Ulaanbaatar, which opened that engineering companies as well as month. Jelena is a certified funds and banks wishing to accountant in Mongolia and is structure their investments into currently in the process of Mongolia. applying for a Mongolian audit license. 9. Dun & Bradstreet media release, 21.09.10 10. London Stock Exchange media release, 18.01.11

6 Russia & CIS Express When is a Door Not a Door?

The answer to this English school riddle is, of course, ‘when it’s a jar’. Open to Optimism In a similar way, ten years of drama in the capital markets taught us to think of them, like doors, as existing in either an “open” or “shut” And so when towards the end of state, but very rarely did we think of them as “ajar”. Citi’s capital 2010, after two very “shut” years, markets execution team takes a closer look at the capital markets. the tide of economic news seemed to have turned it was only natural to enter 2011 brimming with EMEA, IPO and Market Activiting 2001 to 2011 YTD optimism. We had, after all, weathered the worst fallout of a 120,000 400 generation and there was hope that the capital markets would respond 100,000 350 to the new state of affairs and, m) 80,000 conveniently and obligingly, throw 300 e ($ themselves “open”. lu 60,000 Va 250 eal 40,000 Markets in 2011 have, however, D

O been more measured. The early

IP 200 20,000 part of the year has been characterised by equity money 0 150 2001 2002 2003 2004 2005 2006 2007 2008 2009 20102011 flowing out of the emerging IPO Deal Value ($m) DJ STOXX 600 (right axis) markets, ever the high risk high Source: Dealogic reward part of the market equation, and into the perceived “safe haven” of developed markets. This trend was initially led by improvements in Inflows into Emerging Markets in 2010; US fundamentals, but gained into Developed Markets 2011 YTD momentum in response to the

6 political events in North Africa and, most recently, the natural 4 catastrophe in Japan. Pockets of 2 secondary market resilience existed, 0 especially in Russia, partially ons Billi (2) insulated by rising oil prices and in $ $ (4) relative political stability and US Poland, with its captive domestic (6) Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10Jan-11 investor base, but investor sentiment remained fragile and, against this 2010 2011YTD backdrop, it has not been a EM: $95.6bn Inflows EM: $3.4bn Outflows DM: $65.1bn Outflows DM: $31.2bn Inflows straightforward matter to execute EM DM an IPO.

Source: CIRA, Bloomberg Nonetheless, Citi’s equity strategy research team remains upbeat on the prospects for CIS and the broader emerging markets. A good foundation exists for equities as an asset class: economic fundamentals are robust, the global economic

Spring 2011 7 recovery is intact, corporate earnings short term therefore we expect remain resilient, fund flows are investors will be more selective and positive and returns on non-risk more price sensitive than they are in assets are anaemic. Absent another more stable markets. And despite unexpected negative development the sticker shock of the delay of we expect there to be a rebalancing transactions such as ISS, the of equity money flows back into the successful completion of a number emerging markets as investors regain of IPOs in recent weeks underlines confidence and seek opportunities that demand remains for high for enhanced growth. There are quality issuers at the right price. As already early signs of this starting to further testament to this, a number materialise. (See Figure 1) of IPOs, including Etalon Group, Euroset, Nomos and Rusagro in It should not really come as a Russia, continue to launch despite surprise that while an economic the heightened execution risk that shock can have an almost immediate has seen a number of high profile impact on markets, causing them to transactions postpone. (see Table 1) snap shut, the act of re-opening them takes somewhat longer. Likeability, Liquidity and Rather like reputation, investor Leadership confidence tends to be lost in yards but only regained in inches. In the So a critical question for prospective issuers becomes the assessment of Figure 1: Recent EM Fund Flows what kind of transaction is likely to meet with success and how, given the volatility in market conditions, 9 1.5% they should prepare.

) ) 6 1.0% bn

S$ Russia remains the centre of a huge 3

(U 0.5% s ts volume of planned and potential ow

0 sse Fl 0.0% activity. While there is an a ly of

ek established bedrock of interest in -3 -0.5% %

We CIS and Russian opportunities, -6 -1.0% there are several themes to which prospective issuers need to be alert. -9 -1.5% One is the ability of an issuer to Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 differentiate itself. In a market Pan-EM AsiaEx Latam CEEMEA Total (% of assets, RHS) which has tended to be dominated Source: EPFR by issuance from specific sectors,

Table 1: EMEA IPOs >USD 100m in 2011 YTD

Size Pricing Date Issuer Country Sector (USDm) IPOs 23/03/2011 Open Finance SA Poland Finance 156 21/02/2011 Aker Drilling Norway Oil & Gas 635 14/02/2011 Justice Holdings UK Finance 1,440

08/02/2011 Hydraulic Machines & Systems Russia Machinery 360 03/02/2011 Derby Cycle Germany Transportation 105 31/01/2011 Bizim Toptan Turkey Retail 248

27/01/2011 InterXion Netherlands Telecoms 305 24/01/2011 Italy 1 Investment SA Italy Finance 204

Source: Dealogic

8 Russia & CIS Express Moscow International Business Centre, Moscow, Russia

such as natural resources, there is clear upside potential for companies offering exposure to less accessible sectors. Cases such as mail.ru have demonstrated that where a story stands out, money will follow. Issuers and their advisors will need to work harder than ever to make sure that their equity story is robust and presents a compelling or ‘must own’ investment proposition.

Liquidity remains a key topic. Investor concerns on this point during the early months of this year, combined with high volatility, meant that it was easier to find buyers for billion dollar opportunities than 500 million corporate governance and minority market windows can be brief, there dollar opportunities. Investors want protection is a great way to help is no alternative to being ready. reassurance that, if markets become investors build confidence in a story, More than ever, the ability to fragile, they are able to trade their especially where there is a majority execute at speed when the door positions. This ‘liquidity argument’ or dominant shareholder. swings open can be the difference can also impact upon valuation Companies better able to convince between success and failure. So expectations as investors seek to investors of the strength of this serious prospective issuers should build in a buffer to their valuations commitment are likely to be at a invest the time to prepare well in if they are concerned about their significant marketing advantage advance because the fact remains ability to trade. Prospective issuers come the launch of their IPO. that while an IPO can always be should enter any IPO process alert postponed or delayed, it is nigh on to these tensions and be prepared to impossible to accelerate. The Importance of Being test the market appetite before Prepared in Earnest launching marketing formally to Navigating these challenges maximise chances of success. There is no escaping the fact that an requires advisors who are involved IPO is a process intensive project. in the daily flows of capital through Corporate governance is another Preparation takes months and the markets and who maintain ‘hot topic’ for investors, and one involves subjecting the company to constant dialogue with investors to often particularly relevant to extensive investigation by be able to understand and help Russian issuers. Adherence to accountants, bankers and lawyers. issuers react to their concerns. international best practice on But in an environment where

Roger Barb Stuart Perowne Managing Director Associate Head of ECM Execution ECM Execution Citi Citi [email protected] [email protected]

Roger is a managing director in Stuart is an associate in Citi’s Citi’s European investment bank equity capital markets execution and heads the European equity team. capital markets execution team.

Spring 2011 9 The land of opportunity – Russia’s surging demand for new infrastructure investment

Russia’s infrastructure sector has been sorely underfunded since the fall of the Soviet Union in the early 1990s. To put this into perspective, while China has invested 8-10% of its GDP in infrastructure in the last two decades and India has invested 6.4% of GDP, infrastructure investment in Russia stands at just 1-2% of GDP over the same period.

The scale of investment needed in of private investment (spanning Russia is enormous by any direct private investments, PPPs, standards. In 2007, President Putin concession structures etc). estimated that US$ 1 trillion was needed to modernise Russia’s The 2008/9 financial crisis was a infrastructure over the next 10 difficult period for the years, with the federal authorities infrastructure sector, paralysing planning for the bulk of this amount most of the large projects that had (up to 80%) to come from the been signed up to that point. Now, private sector. Precisely how this as markets continue their recovery, should be achieved continues to we are seeing a revival of interest in receive active consideration at all the sector, with many investors once levels of government – with a again ready to consider Russia risk high-level focus on fostering the and long-term investments. right environment for various forms

10 Russia & CIS Express acting as a financial advisor to Ural Industrial-Ural Polar with several projects already actively seeking financing • The water utilities sector has been active, and concessions are being finalised with private (including foreign) players including Remondis, Veolia Voda SA and Alfa Group • Various sport facilities are being constructed with support from large Russian companies including Gazprom, Russian Railways, Inteross, Lukoil and VTB.

The drivers of change… This broad-based surge in demand for new infrastructure is being driven by various factors. These include the rapid development of Russia’s oil and gas sector – and the need for an accompanying A world-class infrastructure in • Multiple PPPs and concessions in infrastructure capable of supporting prospect the St Petersburg and Moscow its onward growth (eg ESPO, Nord regions, such as the Western Steram and Southern European Against this backdrop, Russia has High-Speed Diameter (‘WHSD’), pipelines). announced one of the world’s largest the Orlovsky Tunnel, the infrastructure programmes. Odintsovo Bypass (Moscow- Russia’s host role for the 2018 World However, these are early days and Minsk), sections of the Moscow-St Cup, Formula 1 and the 2014 Sochi while there have been some Petersburg Highway, the Nadex Olympics will require substantial successful examples of large projects light rail (St Petersburg) and the infrastructure development, not just achieving financial close (for Pulkovo Airport expansion in terms of stadia and facilities, but example, the Moscow-St Petersburg projects; these range in size from also across the transport, toll road, which has capital costs USD 600 million (Moscow-Minsk communications and hospitality estimated at around € 1.5 billion), it road detour) to US$ 7 billion sectors. The Russian government is is clear that a lot of work remains to (WHSD) actively encouraging private be done before such landmark investors to take part and a number developments become a mainstream • JSC Ural Industrial-Ural Polar (set of non-PPP projects associated with and accepted way forward. up and owned by the regional these events are being sponsored by governments of the Urals) has state-owned and private corporates The following selected examples developed a programme to invest (airports, high-speed rail, stadia, show the sheer scale of opportunity, in the infrastructure of Russia’s power plants and investments in in terms of the private investments Ural region with around USD 30 power distribution, for example). in infrastructure projects that have bn of projects under already been approved: consideration; PwC Russia is

Spring 2011 11 Russia’s host role for the 2018 World Cup, Formula 1 and the 2014 Sochi Olympics will require substantial infrastructure development

More fundamentally, following its investments. Regional legislation … but some barriers remain partial privatisation a few years ago, has also been introduced to give Notwithstanding the enormous Russia’s ageing electricity investors more flexibility in non-PPP progress that has already been generation industry is expected to projects. For example, the Nadex made, much remains to be done. require very substantial investment light rail and Pulkovo Airport have Successful projects are across the nuclear, coal and been conceived as the first PPPs predominantly clustered around St hydropower sectors. Healthcare is based on regional St Petersburg Petersburg and Moscow, and there another basic requirement, and with legislation. have still been very few successful per capita spending in this area still initiatives at the regional level. low compared to other developed The environment for private sector Meanwhile, on a bureaucratic level, countries, a number of targeted investors is rapidly gaining in although Russia recently introduced regional and federal programmes sophistication – and in stability. For a new regulatory framework to have already been launched. example, the establishment of provide comfort for investors institutions such as the Investment looking to finance future Government support of technology Fund of the Russian Federation and infrastructure projects, some and innovation is driving the the rapid development of state- discrepancies regarding concession, creation of infrastructure related to owned Vnesheconombank have security, and tax and budget scientific clusters and industrial enabled Russia to channel state legislation still need to be overcome parks (Skolkovo is just one example funds as a co-investor on market in order to bring creditors’ of this trend). And the facilitation of terms alongside private interests. protection in line with international trade links is another important Specific features include: best practice. factor, with the planned Pan-Asian freight corridor and the • Vnesheconombank (VEB) has It is important to remember that commercialisation of the Northern made infrastructure one of its top Russia has its own technical, Sea Route (NSR) standing out as priorities, and is now offering construction, sanitary and other very significant initiatives (the latter investors ruble-denominated standards – and that these can often means good prospects for port loans at favorable fixed rates be rather different to those that construction along the Northern • State support is available through apply in comparable situations in Russian coast, offering new routes the Investment Fund, including the West (although sometimes for in and out of Russia and between co-financing under investment good reason). This can limit Europe and Japan). agreements with provision of companies’ ability to apply best ownership rights in Russia, practice in project design and can The Russian government has allocation of funds to the share result in less than optimal solutions. committed to support private capital of legal entities and state In extreme cases this may result in investors that decide to invest in the guarantees of investment projects. projects that are bankable in the country’s transport infrastructure, West failing to meet minimum with significant progress already financial return requirements in having been made in developing an Russia. institutional and legal framework and special tax regimes for such Given the potential for volatility, there are concerns over hedging currency and pricing risks. While instruments are available to manage these issues, their application can mean that project economics are adversely affected – sometimes to an unacceptable degree.

12 Russia & CIS Express Last but not least, there is still a The country’s vast size and varied Bibliography limited track record of successful geography mean that many projects 1. Advancing Public Private Partnerships projects – although there is a sincere are much larger than their in Russia. PwC, 2010 hope that the few PPPs and other equivalents elsewhere – meaning initiatives brought to market in that the opportunities for 2. Build and Beyond: The (r)evolution of recent years will serve to reassure involvement are exciting and healthcare PPPs. PwC, 2010 by highlighting the successful broad-based. Supported by a high 3. Russia Infrastructure Report Q2 2011 outcomes that can be achieved. oil price and a willingness for state Including 10-Year Industry Forecasts institutions to co-invest, we are By BMI optimistic that the prospects for Looking ahead infrastructure investment in Russia 4. Russia’s Infrastructure at the Crossroad Despite the recent economic crisis are exceptionally strong. The main – The Key to Modernization. USRBC and some legislative, administrative challenge, looking ahead, will lie in White Paper. Washington, DC, 2010. and fiscal barriers, Russia has a matching international best practice 5. “Russia. Global trends, local manifest strong demand for new with local execution – an area where implications” by Renaissance Capital, infrastructure and offers a wide the relevant authorities continue to September 17, 2010 range of opportunities for investors, work closely alongside specialist developers and construction international advisers such as PwC. 6. Investing in the infrastructure companies. development of the Russian Federation: the EBRD perspective. Thomas Mirow, EBRD President

7. Infrastructure as economy growth driver, by Vladimir Kondratiev

Julian Smith Anna Topoleva Construction, Procurement & Senior Manager, Construction, Infrastructure leader, Procurement & Infrastructure, PwC Russia PwC Russia [email protected] [email protected]

Julian is global leader of the Anna is a Senior Manager in the transport infrastructure finance CP&I and Debt Advisory unit in group and is now based in Moscow. PwC Russia. Previously she He specialises in advising the public worked in Lead Advisory and was sector on port and rail involved in projects ranging from infrastructure deals, especially financial advisory to oil and gas, concessions. Julian transferred from as well as to mining companies, PwC UK to PwC Russia earlier this industrial products manufacturers year. Before moving, he was the and public institutions. leading Corporate Finance advisor to the Department for Transport, focusing on M&A and PPPs, including the £1.5 billion PPP for the widening of the M25.

Spring 2011 13 be substantial pressure to boost populist spending – particularly on pensions, social security, and other social programmes – in the run-up The view from to elections. But Russia’s highly respected finance minister, Alexei Kudrin, is expected to hold the line the hustings on excessive spending growth, and has indicated that tax hikes may be implemented to help compensate for On the back of a broadly stable political backdrop, and an higher spending. improving macroeconomic situation, the outlook for the Russian investment environment in coming months is Russia’s fairly stable political backdrop and improving cautiously positive. Any broad-based effort to tackle the macroeconomic situation underlying structural challenges to the investment notwithstanding, the country’s environment, though, will be relegated to the back burner investment environment remains until after the end of election cycle in 2012. challenged by the endemic issues of corruption, rule of law, and personalised politics. The ongoing so-called modernisation campaign, Russia is entering an election pushed full-year growth to 4% for focused on the diversification of the season, with parliamentary polls set 2010. Following an extended period Russian economy beyond the for December 2011, and the of underperformance during most of extractive industries, is unlikely to presidential ballot in March 2012. the second half of 2010, the ruble has yield material results in the medium At this point the risk of political rallied, moving up sharply against term. Whether after elections the instability in the run-up to elections the dollar since its autumn lows. The Russian government will launch a is very low. The country remains budget deficit for 2010 clocked in at comprehensive reform program to firmly under the control of Prime 4%, significantly lower than address the underlying structural Minister Vladimir Putin, President anticipated earlier in the year. weaknesses of the economy remains Dmitry Medvedev, and the ruling Commodities prices – and the oil to be seen, although indications at this United Russia party. Nevertheless, price in particular – remain the point are somewhat encouraging. some dislocations are possible as single most critical factor in Russia’s jockeying among political and macroeconomic outlook, so recent economic elites will intensify in price strength suggests that Kim Iskyan coming months, as the country’s consensus forecasts for growth, the Russia Analyst, leadership moves towards a decision ruble and the deficit will be upgraded Eurasia Group on whether Putin will return to the in coming weeks, particularly as the Iskyan@ Kremlin in 2012. At this point it Finance Ministry’s $75/barrel oil eurasiagroup.net appears on balance likely that Putin price assumption appears will stand for president again; given increasingly conservative. his perennially high approval ratings and the dearth of real Inflation and rising fiscal opposition, there is a high expenditures stand out as the most Kim Iskyan is a director in Eurasia probability that the prime minister prominent macroeconomic risks in Group’s Europe & Eurasia practice, would be voted back into the the near term. Inflation has risen based in Washington, DC. He presidency. There is a smaller, sharply in recent months, from 5.5% focuses on analysing a broad range though real, possibility that year-on-year to 9.7% year-on-year as of sectors in the Russian economy President Dmitry Medvedev will of the end of February, primarily on (including the banking, retail/ stand for a second term. Regardless the back of global commodity and consumer goods, automotive, of Putin’s precise role, however, food price growth. Encouragingly, machinery, airline, and media there is almost no question that he the Central Bank of Russia in late sectors) as well as on will remain a key decision-maker in February raised interest rates and macroeconomic and investment the Russian political structure. widened the ruble foreign exchange issues relating to Russia. corridor, to allow for greater On another front, Russia’s post- appreciation – and appears to be economic crisis macroeconomic adopting a more proactive stance to rebound appears to be accelerating. counter rising prices. On another Fourth quarter GDP growth of 5% front, in coming months there will

14 Russia & CIS Express Artist’s rendering of the Sochi 2014 Coastal Cluster

in public attitudes to disability nationwide.

The Sochi 2014 ‘journey’ will continue long after the Games have concluded. All Games preparations comply with rigorous local, national and international environmental regulation, safeguarding the region’s ecosystem and setting a new standard for environmentally- efficient construction throughout Russia. At a grass-roots level, Sochi’s Sochi 2014 sporting infrastructure will deliver lasting benefits to future generations. Some of the venues, when the world is watching including the ice-hockey stadium, will be deconstructed and relocated after the event. And the new Russia As the host city for Russia’s first ever competitions. Most recently, in International Olympic University, Winter Olympics – the XXII Olympic February 2011, this saw the being built in Sochi, will produce a Winter Games and XI Paralympic mountain slopes at Rosa Khutor new generation of sports managers, Winter Games – Sochi is now hosting the European Cup stage in satisfying demand in Russia and preparing to be a focus for downhill and super giant slalom. worldwide for highly-qualified international attention in 2014. Just one of a series of 25 test events specialists in event management, scheduled to take place over the governance and sport diplomacy. Since 2007, when the International next 30 months, this assurance Olympic Committee finalised its exercise allows venues to be put In its exclusive role as Official decision in favour of Sochi’s bid, a through their paces well in advance Professional Services Provider and massive programme of development of 2014. Partner of the XXII Olympic and has been underway in Russia’s Black Paralympic Winter Games, PwC Sea region. Besides funding a new, As well as marking a defining Russia is now working with the Sochi state-of-the-art national winter moment in the development of Sochi 2014 Organising Committee on over sports centre, the US$9.7 billion and the Krasnodar district, the 2014 70 projects spanning the planning, investment is set to transform the Winter Olympics is a project of preparation and staging of the local and regional infrastructures, national importance for Russia. Games. Focused on ensuring the turning the surrounding Krasnodar From the outset, the Sochi 2014 Organising Committee gets to the 7 district into a year-round tourism Organising Committee has been February 2014 starting-line in peak destination supported by new air, focused not just on ensuring that the condition, our activities span multiple road and rail links, alongside Games are staged in harmony with competencies, including taxation, upgraded utility projects, 21st the IOC’s requirements, but also on human resources, risk management century communications and new shaping an Olympic legacy that adds and sustainability, marketing, resort facilities. To put the scope of value to Russia and to the Olympic/ financial planning and budgeting. development into perspective, Paralympic movement. according to the IOC, this is the first Much of our work is breaking new time an Olympics project has been Central to the Sochi 2014 vision is ground in the field of event planning attempted on this scale. its strong socio-cultural legacy of at this level. In particular, PwC regional development, volunteering Russia has been collaborating closely Progress is well on target, with and Paralympic awareness in with the Sochi 2014 Organising approximately 70 percent of Russia. As well as establishing Sochi Committee , bringing its global construction now completed. Some as a diversified, world-class hub of experience and local commitment to Olympic venues have already been sporting activity, this sees the bear to pioneer a new integrated, tested in international sports Paralympic Games driving a change client-oriented approach to Games

Spring 2011 15 preparation. By incorporating this complex, multi-project the Organising Committee realise Project Oriented Organisation into engagement assumes that all related its larger vision. As such, legacy its planning, the Organising work for Sochi 2014 is a set of planning is key to our involvement Committee will manage the interlinked programmes and in this project. Through our seamless transition from its current projects. While pursuing their own Corporate Responsibility 300 members to the more than objectives, each of these projects is programme, as well as direct 3,000 members needed to stage the subordinate to the overall Games sharing and collaboration between Games, keeping firmly on track for a strategy. To give some idea of the PwC Russia and Sochi 2014 people successful event without losing sight scale of planning involved, the beyond the framework of strict of core longer-term legacy operational work plan accounts for project delivery, we hope to objectives. over 2,600 events and control contribute to the vital long-term points. This model provides a legacy objectives. Robert Gruman, Recognising PwC Russia’s mobile ‘template’ that can be applied Partner and Advisory Lead at PwC contribution to ‘National Project #1’, elsewhere in Russia and in emerging Russia, continues: “As well as Dmitry Chernyshenko, President economies worldwide, adding a infusing PwC’s global sustainability and CEO of Sochi 2014 Organising layer of control and experience to know-how into the overall planning Committee, says: “When holding the staging of large-scale events. process, we are also able to share such large-scale events as the international experience acquired Olympic and Paralympic Games, it is Another major project undertaken by by the firm in carrying out projects critical to have business partners PwC Russia has been the for Olympic and Paralympic Games you can rely on. PwC has been development of a Performance in other countries. One of the main active in Russia for more than 20 Management System. Incorporating a benefits for PwC is that our firm and years and has made significant sum of strategic and operational key our people in Russia have been contributions to Russia’s economic indicators, scaled to apply to Sochi given a unique opportunity to development. The firm has always 2014 overall and to each team develop personally and been distinguished by the fresh member individually, this ensures professionally through Sochi 2014.” approach and original thinking of cohesion between the Sochi 2014 its people in meeting new Organising Committee high-level These Games are set to have a challenges, which is exactly why we strategic objectives and the day-to- major, lasting impact on the future have chosen them.” day work of each individual employee of investment and innovation in in the run-up to the Games. Russia. As the countdown to 2014 The ‘Sochi model’ that we have continues, the first phase of created to coordinate and manage PwC Russia is committed to helping investment (focused on new build in the Olympic region) is gathering pace. Once that is concluded, the second wave will drive far-reaching transformation throughout the surrounding region. Just as Barcelona’s regeneration did not end in 1992, so the lasting impact of Sochi’s unique journey will be felt for years to come.

We look forward to bringing you further updates on Sochi 2014 in future issues of this publication.

To find out more about Sochi 2014 please contact Robert Gruman Partner PwC Russia BV [email protected]

16 Russia & CIS Express Profile: Sir John Stuttard

Co-Chair of the Kazakh-British Trade & Industry Council, and Chairman, PwC Kazakhstan Advisory Board

financial institutions and its emergence as a global financial centre, Russia is being held back by the lack of certainty around contract law and the regulatory environment. Russia would become much more successful if these weaknesses were dealt with, and the legal and regulatory regimes were made more reliable and Taking the long-term transparent.” So, is the will there to achieve this change? “Yes, I think the will is view there—the question is whether it actually happens,” he replies. “That’s a question for the future.” Whatever the immediate Sir John Stuttard’s horizons have and finance. He also hosted a uncertainties in Russia and the CIS, always extended far beyond his delegation to London led by Sir John is excited and energised by native UK. “When I joined PwC in President Nazarbayev of Kazakhstan the longer-term opportunities for its former guise in the mid-1960s, in 2006, and led a pioneering PwC and other businesses, and for one of my objectives was the business delegation to Kazakhstan London’s role in the region. “From opportunity to travel and deal with in 2007. He was so impressed by the PwC’s point of view, I think it’s very other countries,” he recalls. country’s potential that he became important that we should be Chairman of the PwC Kazakhstan His career to date reflects this global engaged in these markets because of Advisory Board in 2008 and Co- view. Much of it has been devoted to the tremendous opportunities they Chair of the Kazakh-British Trade & advising global businesses—whether offer,” he says. “And it’s vital that we Industry Council in 2009. helping companies from the Nordics build up expertise and knowledge list on the London Stock Exchange in Looking at the current change under about these countries in London and the 1980s, building up PwC’s way in Russia and the surrounding other centres—which is exactly fledgling operations in China in the region, Sir John draws some what we have been doing.” 1990s, or forging strong business interesting parallels with the relationships in Kazakhstan and opening-up of China in the 1990s. Russia as he does today. “Initially there was something of a gold-rush into China 1993-95, when Sir John’s current focus on Russia “If Russia and the CIS everyone wanted to invest there,” he and the CIS began between 2005 and explains. “ Then around 1997 are open for business, 2007 during his tenures as Sheriff of people became more aware of the the City of London and then Lord risks—especially regulatory and then people are very Mayor of London. His main role as legal risks, and the lack of certainty Lord Mayor was representing and ready to go there. around contract.” In Sir John’s view, promoting the financial, maritime similar challenges face Russia’s And I am pleased that and business services industries that potential to become a global centre underpin London’s position as the for financial services. PwC is well world’s leading international financial centre. “In natural resources, Russia is of established there.” course hugely important, because of In the course of these duties, Sir its enormous reserves of gas and John visited Russia and met many other resources,” he comments. “But leading figures in Russian politics in terms of the development of its

Spring 2011 17 Russia’s banks back on the investment radar

Bank lending and deposit levels in in underwriting and credit analysis, NPLs (like in other markets, their Russia are seeing a strong which exacerbated the levels of true value is often significantly resurgence as the sector emerges non-performing loans (NPLs) below book value), raise additional from the financial crisis. With created by the downturn in the capital or to participate in multiples still below their pre-crisis economy. consolidation of the sector. levels, could this be the time to take a fresh look at investing in Russia’s The Russian government spent some Emerging from the crisis banks? $125 billion in support of its banks in 2008 and 2009. It also increased Following the government-backed Having rebounded from the Russian retail deposit protection to $23,000 stabilisation, the banking sector is financial crisis of 1998, the country’s and has carefully managed the now bouncing back strongly. banking sector was growing at sector’s approach to provisioning on Russia’s banks recorded a net profit around 50% a year leading up to the overdue loans for Russian Statutory of around $20 billion in 2010, with global financial crisis (see Figure 1). reporting purposes. Official corporate lending rising by 12% and This phenomenal expansion provisioning rates doubled in 2009 retail loans by 14%. The CBR attracted a number of international to more than $30 billion at the anticipates that overall lending will banking groups, with acquisitions beginning of 2010 (5% of increase by 20-25% in 20115. In by Italy’s UniCredit (International outstanding loans); how NPL addition to loan and deposit growth, Moscow Bank in 20071) and provisioning is managed by the there has been some recovery in net Austria’s Raiffeisenbank Central Bank of Russia (CBR) going interest margins towards pre-crisis (Impexbank in 20062) propelling forward is of fundamental levels. them into the list of Russia’s top ten importance to the sector. Certainly banks by assets (see Figure 2). there is currently limited A particularly encouraging sign is incentivisation for banks to sell the increase in retail deposits, which Although the impact of the global financial crisis came late to Russia, it hit particularly hard. In addition Figure 1: Total value of banking assets to the pressure on liquidity created by global instability, Russia’s 1,200 banking sector was affected by a number of local factors including 1,000 currency volatility, a comparatively 800 low level of retail deposits and an increasing reliance on international 600 capital markets for funding. The breakneck speed of growth had also USD in billions 400 not been matched by developments 200

Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09 Dec 10 Total assets Total loans

Source: Central Bank of Russia

1. UniCredit media release, 28.12.06 and www.unicreditbank,ru, 21.02.11 2. Raiffeisen Bank International media release, 01.02.06 and www.raiffeisen.ru, 21.02.11 3. Reuters, 23.11.10 18 Russia & CIS Express 4. Central Bank of Russia statistical update 2010 Russian banking at a glance

• Assets of just over $1 reached $322 billion in December Investment potential trillion 2010, having risen by more than This is an interesting juncture • Over 1000 banks 60% since January 20096. The CBR for foreign investors. Some expects deposits to rise by a further • Upper end of market is international groups have been 26-28% in 20117. Having been reviewing their investments in highly concentrated, with shaken by the bank failures of the the wake of the crisis; others 1998 crisis, the rise in deposits top 20 banks accounting have continued to perform reflects a welcome increase in public relatively well and are now for 68% of total assets confidence in the banking system seeing a return to growth. and, if sustained, will boost long- and top 50 for 80% of Groups looking to establish and term stability and access to funding. strengthen their presence in the assets Russian market might see this The deal market declined significantly • State banks still dominate as an opportune time to invest. during the instability of 2009. Now, Figure 3 sets out the price/book (six out of top ten), with however, we are seeing renewed values of the country’s two market confidence in the sector, which 48% of the sector’s total largest banks on either side of was reflected in VTB Bank’s successful the global financial crisis. assets placing of $3.3 billion worth of shares 8 Current transaction values are in February 2011 . Source: Central Bank of Russia

Figure 2: Top 10 banks by total assets at 31 December 2010

Total % of assets banking Bank USDbn assets* Ownership Sberbank of Russia 279 25.2 State-controlled via CBR, 60.6% VTB Bank 91 8.2 State-controlled via Federal Agency for Sate Property Management, 85.5%** Gazprombank 59 5.3 State-controlled via Gazprom and NPF Gazfond, 91.7% Rosselkhozbank 34 3.0 State-owned via Federal Agency for Sate Property Management, 100%

Bank of Moscow JSB 30 2.7 State-controlled via Moscow State Property Department and SSG, 63.5%*** VTB 24 29 2.7 State-controlled via VTB, 95% Alfa Bank 26 2.4 Privately-owned UniCredit Bank 22 2.0 Foreign-owned Raiffeisenbank 16 1.4 Foreign-owned Promsvyazbank 15 1.4 Privately-owned

*- % of total Russian banking sector assets **- VTB placed 10% during SPO in February 2011, attracting USD 3.3bn ***- VTB purchased 50.48% of Bank of Moscow shares from Moscow State Property Department and Stolichnaya Strakhovaya Group (SSG) in February 2011 Source: Central Bank of Russia

5. Reuters, 07.02.11 6. Central Bank of Russia statistical update 2010 7. Moscow Times, 09.02.11 8. Reuters, 14.02.11 Spring 2011 19 much lower than 2007 and 2008. innovation and improve the quality fast-growing institution that has While multiples have been and delivery of products and established country-wide coverage recovering again, they are unlikely services. Every year, we carry out a without branches. to return to the very high levels seen customer experience survey of before the global financial crisis. Russian retail banks in association Build or buy? with Senteo, a market research With banking penetration and company, which rates the quality of As Citibank has shown, green field development within Russia still low, the brand, offering, environment, development is a feasible option, especially outside the main urban communications and customer- though it can be a relatively long centres, the long-term growth centric culture. The average rating haul – Citibank is Russia’s 19th potential remains strong. The for Russia’s banks lags some way largest bank, having been combined assets of Russia’s banks behind their counterparts in the established in 1993. It can take at are only around 70% of GDP9. In Ukraine, Slovakia and the Czech least a year to secure a licence and Brazil, a fellow ‘BRIC’, bank assets Republic (see Figure 4). In contrast, foreign institutions must be fully are around 105% of GDP10. By 2050, foreign banks operating in Russia incorporated rather than operating our analysis suggests that the asset have consistently scored above the as a branch. Once up and running, size of the Russian banking sector Russian average, providing them entrants face entrenched competition will be on a par with Italy or Spain11. with a valuable competitive from established players – while advantage. A differentiated there are over a thousand banks in The crisis has in turn increased the approach in Russia also may bear Russia, the six largest institutions, all appetite for foreign investment and fruit – TCS Bank is an example of a state-owned, account for 48% of the acquisition. Many mid-tier banks market by assets. (including those in the 10-50 in the size ranking) may be especially keen to attract a foreign buyer as Figure 3: Price/book values of VTB and Sberbank they seek to gain access to the funds and expertise they need to sustain 5 growth and compete with the larger institutions. 4 Within a relationship-driven 3 corporate banking market, many of the mid-tier banks rely on around 20 clients for up to 50% of their 2 business. This limited client base is making it difficult to sustain 1 growth. Some institutions will look to foreign investors to develop the 0 scale, differentiation and risk management capabilities they need to accumulate further market share. Sberbank VTB

Within retail banking, many banks Source: Bloomberg and PwC analysis may seek outside assistance to boost

9. Central Bank of Russia and CIA World Factbook 10. Central Bank of Brazil and CIA World Factbook 11. ‘Banking in 2050: How big will the emerging markets get’, published by PwC in 2008

20 Russia & CIS Express As UniCredit and Raiffeisenbank Figure 4: Retail bank customer experience ratings have shown, acquisition offers a faster way to establish a strong market presence. As reported 3.85 earlier, a number of mid-market 3.7 3.66 institutions may now be up for sale. 3.43 However, buyers need to be aware of the challenges in the Russian banking environment and have clear plans to address them before making a deal. These include a general shortage of qualified and experienced bankers in the Russian market, along with issues relating to IT infrastructure. As businesses may Czech Republic Slovenia Ukraine Russia not be properly prepared for sale, the deal execution phase can also Source: Customer Experience Index 2010’, published by PwC in association with Senteo prove lengthier and more challenging than in more developed markets.

Brief window of opportunity supporting the purchased business. Patient and careful due diligence Andrew Cann Russia has a rapidly evolving will also be critical, especially as the Director, banking sector, which presents both prevailing provisioning rules may Transaction Services, opportunities and challenges for make it difficult to ascertain the true PwC Russia international groups looking to take level of bad debts. Nonetheless, with [email protected] advantage of its considerable the right price and the right growth potential. With many strategy, Russian banking is and will mid-tier banks looking for buyers continue to be a highly profitable and multiples still some way below investment opportunity. Andrew leads the dedicated their pre-crisis peak, this could be a financial services due diligence good time to consider an team in Moscow. Since relocating acquisition. However, prospective to Moscow he has advised buyers will need to move fast as international and domestic prices are climbing back up again investors on a wide range of and transactions can often take financial services transactions in more time to complete than in a Russia and Poland and the wider more developed market. CEE/CIS region. It is important to establish a clear and differentiated strategy for growth and be prepared to invest significant sums in developing and

Spring 2011 21 Belarus – prospects for growth?

Belarus’s central European location machinery factories saw their sales urgently-needed foreign investment. is generally acknowledged to be one to Russia drop by up to 50 percent in Reported by the Financial Times of its principal attractions for 2009. This spurred attempts by the newspaper, this includes plans to foreign investors. Sitting at the government to develop new markets privatise 244 state-owned crossroads of major transport and – specifically in western Europe – companies, machine tool, power communications links between the with companies across this sector generating and construction plants. EU, Russia and Ukraine, the country seeking to establish joint production is well placed for accessing the facilities to help win new contracts. To an extent, this greater openness markets of the Former Soviet Union. to foreign participation fits with a Up to this point, the autocratic broader trend for increased The country’s relationship with president, Alexander Lukashenko, liberalisation, designed to stimulate Russia has shaped its history and its had been reluctant to introduce growth and release pressure on the economic development. From the reforms that might undermine his country’s fast-growing times of the USSR, Belarus has been rule. But the severe economic crisis entrepreneurial segment. Amongst a major supplier of plant and engulfing Belarus left him little the raft of reforms brought in during machinery to its neighbour, to the choice. And, if anything, the 2007-2008, some of the most extent that its economy became country’s problems have intensified significant included the introduction synonymous with heavy industry. since the elections in December of a 12 percent flat-rate income tax, That continues to be the case today, 2010 that saw Mr Lukashenko allowing an increase in the foreign with almost 90 percent of the retaining power – largely because of ownership of individual banks from tractors used in the Former Soviet the wage rises and spending 25 percent to 50 percent and Union (FSU) being built in increases that were introduced at terminating the ‘golden share’ Belarusian factories. that time. system (which entitled the government to take over previously More recently, however, the Now, faced with rapidly diminishing state-owned businesses where they economy has been mired in foreign currency reserves, rising were considered to be at risk). difficulties and when the global natural gas prices and a yawning financial crisis hit, the impact was trade deficit, the government has However, while the short-term dramatic. State-owned heavy announced further steps to kickstart impact of these various reforms

22 Russia & CIS Express Independence Square, Minsk, Belarus

potential opportunity. While the banking sector is now partly privatised, insurance continues to function, to a large extent, as a state monopoly; although formally there a number of private insurance companies, they are not permitted to write most of the state-related or compulsory types of insurance. That said, the fast-growing middle class combined with ongoing liberalisation means that this situation is likely to change rapidly, and demand for insurance products can only increase from today’s low penetration rates (at around 1 percent). Anticipating this surge in demand, a number of international insurers (including Vienna remains to be seen, the long-term available at relatively low wage Insurance Group, ERGO, Generali- potential for foreign investment may rates and there is still little PPF, AXA, Rosgosstrakh and now be more encouraging. The competition. Indeed, amongst the Ingosstrakh) have already bought World Bank’s ‘Doing Business’ countries of the FSU, Belarus into some of the smaller local annual report now ranks the continues to have a relatively low companies. Their example will help country fourth in the top-ten average monthly wage – USD 376 in to build the critical mass needed to reformers of business regulation. 2008, compared to USD 732 in accelerate further reform. And in terms of doing business, Russia and USD 836 in Lithuania Belarus now ranks 58th out of the (source: National Statistical Bearing in mind the country’s 183 countries under review. Committee of the Republic of strategic location between the Belarus). countries of the FSU and western There is, of course, much more to be Europe, additional opportunities for done. But there is an emerging Provided that Belarus continues foreign investment lie in the consensus that, subject to the with its liberalisation programme, chemical and petrochemical resolution of immediate political rises in living standards are industries – significant for and economic tensions, Belarus expected to fuel the ongoing boom producing high-quality potash, does now represent a relatively in real estate and construction (now nitrogen and phosphate fertilisers predictable destination for western accounting for 10 percent of GDP). which are in great demand abroad investors. Until now, international contractors (Belaruskali owns 50 percent of the have bypassed the fast-growing Belarusian Potash Co, a joint On a par with developed European residential and commercial property venture with Russian miner Uralkali countries and the US in terms of its sectors, in part because of the that controls about 30 percent of the literacy levels (source: United overly-complex legislation. But as world potash market; source: Nations) and with the highest reforms gather pace, some western Reuters). density of well-educated people European developers will inevitably anywhere in the FSU, there is seek to seize first-mover advantage. Looking ahead, although ongoing growing interest in the country’s privatisation of state-owned potential for high-tech development. Financial services (and insurance in companies remains a challenge and Highly-skilled labour is readily particular) is another area of

Spring 2011 23 further legislation is required, The British Belarus Chamber of Commerce (BBCC) has Belarus represents a relatively been in existence for some years and throughout 2011 will untapped prospect for foreign focus on expanding its membership of UK-based companies. companies attracted by prospects for growth in what remains a This new phase in the Chamber’s development compliments relatively high-risk business some liberalisation steps recently declared by the environment. As Kirill Savrassov, Belarusian government, and further decentralisation and CEO of the British-Belarus Chamber privatisation processes will be inevitable. As a result, in the of Commerce, sums up: “For British short and medium terms, commercial and business businesses that are already opportunities will arise. established in Russia and Working closely with the British Embassy in Belarus as well neighbouring countries, this as the Belarus Embassy in London, the Chamber focuses on represents a great opportunity to organising activities which will, ultimately, facilitate more leverage that experience for repeat business between the two countries. Delegation visits, success – rapidly and for a small seminars and networking opportunities will play a key role level of investment.” in this. The BBCC also offers members access to a database of To find out how PwC Belarus can information on goods and services, as well as lobbying help, please contact Oleg Gvozd, assistance, due diligence services on potential partners in Country Leader, PwC Belarus Belarus, visa support and help with business visits to the [email protected] country. Further information about the Chamber can be found at www. bbelcc.org.uk

Facts & figures

Belarus means “white Russia” Capital: Minsk Population: 9.6 million (UN, 2010) Major language: Russian, Belarusian (both official) Monetary unit: Belarusian rouble; 1GBP=4,879.28BYR Area: 207,595 sq km (80,153 sq miles); Border countries: Latvia 141 km, Lithuania 502 km, Poland 407 km, Russia 959 km, Ukraine 891 km Climate: Because of the proximity to the Baltic Sea (257 meters at the closest point), the Belarusian climate is moderately continental, and ranges from maritime to continental, with mild and humid winters, warm summers and damp autumns. Average temperatures: January -6°C, July 18°C, with high humidity. Economy: Most of the Belarusian economy remains state-controlled and has been described as “Soviet-style”. Thus, 51.2% of Belarusians are employed by state-controlled companies. As of the 1991 dissolution of the Soviet Union, Belarus was one of the world’s most industrially developed states by percentage of gross domestic product (GDP) as well as the richest CIS state. As of 2006, Belarus’s largest trading partners are Russia and the EU. Natural resources: potash, forests, marlstone, peat deposits, small quantities of oil and natural gas, granite, dolomite limestone, chalk, sand, gravel, clay. Main exports: Machinery (tractors), agricultural products, chemical and petroleum products GDP: GDP per capita (PPP): $13,400 (2010 est.); GDP real growth rate: 4.8% (2010 est.) Unemployment rate: 1.1% - (2009 est. official figure) Sources: http://en.wikipedia.org/wiki/Belarus#Economy http://www.noc.by/eng/bsog/htdocs/28/ https://www.cia.gov/library/publications/the-world-factbook/geos/bo.html http://lifestyle.iloveindia.com/lounge/facts-about belarus-2365.html

24 Russia & CIS Express Temple-Mongolia-Ulaanbaatar

Spring 2011 25 Get in touch

Our Team Alex Bertolotti Russia & CIS Business Group Leader +44 (0) 20 7213 1253 [email protected]

Jeremy Foster Sir John Stuttard Partner, Assurance Chairman, PwC Kazakhstan Advisory Board +44(0) 20 7212 5249 +44 (0) 20 7213 4590 [email protected] [email protected]

Nick Page Charles Joseland Editor, Russia & CIS Express Partner, Assurance Partner, Transaction Services +44 (0) 20 7804 4512 +44 (0) 20 7213 1442 [email protected] [email protected]

Liz Henson Clifford Tompsett Partner, Tax Partner, Capital Markets Group +44 (0) 20 7212 6024 +44 (0) 20 7804 4703 [email protected] [email protected]

Alina Listopad Gaziza Nurtuganova Manager Business Development Executive Russia & CIS Business Group Russia & CIS Business Group +44 (0) 20 7804 9398 +44 (0) 20 7804 1033 [email protected] [email protected]

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