Back in October I wrote a post on FDI into Russia & Hermitage Capital, where I discussed the risks foreigners faced when investing in Russia. I also put forth the stranger-than-fiction story of Hermitage Capital and the systematic harassment that fund has faced in Russia.
The tale has taken another grim turn, only further exposing the Russian non-judiciary, the corrupt police force, and the void that exists where the Rule of Law should. Last week Sergei Magnitsky died whilst incarcerated at Moscow's Matrosskaya Tishina prison. Magnitsky was a key figure and instrumental in uncovering the largest ever tax repayment fraud in Russia.
Magnitsky refused to leave Russia, despite the strong encouragement of Hermitage management and his colleagues. As he had committed no crime, he maintained he had no reason to run; implicitly he put is faith in the non-judiciary. His choice killed him almost a year later.
The Telegraph has the story here. Here's a sample:
. . ."He said: 'I have nothing to fear. I have done nothing wrong. I haven't even signed any documents. What have I got to be scared of?'" said Mr Browder. "He was the hero who uncovered the fraud.". . . .
. . .In an emotional outpouring at his final public appearance before his death, Mr Magnitsky accused the authorities of turning his trial into a sham, complaining he was denied his most basic human rights. . . .
. . ."Magnitsky did not die by chance. He died because corrupt Interior Ministry officers killed him. They knowingly imprisoned an innocent man, destroyed his health and denied him access to medical treatment. . . .
. . .In court, after being held for much of the day in what Mr Magnitsky described as "a cage similar to the cages used to keep wild animals", the prosecution served late new evidence to the judge as it sought again to extend his detention. . . .
. . .His cell floor was sometimes flooded with sewage, the toilet was simply an open hole in the corner of the room, the squeak of rats kept him awake at night, he was rarely allowed to shower and was for a long time denied any visits by his wife, sons aged 17 and eight, or mother.
"Isolation from the outside world exceeds all reasonable limits," he wrote.
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It's well known that deploying capital in Russia presents a range of difficulties to be overcome and threats to be thwarted to achieve investment success. Regulatory, legal and bureaucratic hassles, and sometimes corrupt officials, are just part of the landscape. Expropriation of control and/ or equity by dubious judicial means and other quasi-state backed strong arm tactics are rarer. They are however still pulled from the quiver when a particularly obstinate investor, Russian or foreign, won't acquiesce to their partners wishes. Prospective investors need look no further than the experiences of Yukos, Telenor, Shell, TNK-BP, and Exxon to realise they can be parted from their equity with a nod from the Kremlin.
Apparently the Kremlin has turned a new leaf and PM Putin is now spreading the love for some new FDI into Russia. In the last week of September, Putin spoke at length at two different forums to reassure prospective foreign investors that Russia was a fine destination for their capital. From the first outing he stated:
"We would like you to consider yourselves participants in our undertaking," Putin told a meeting in Salekhard, the capital of the Yamalo-Nenets region. "The main condition from our side is that partnerships should be stable and long-term."
Yes, he really said this. Of course the problem is precisely that previous partnerships didn't end up being "stable and long-term" because the foreign investors involved were forced to accept 'renegotiated terms' or have their equity expropriated.
“We will continue the line of encouraging private initiative, integration into the global economy and the creation of a favorable investment climate”
There is a reason Russia is lagging far behind the performance of its fellow BRIC members: foreign investment. The way the Russian state and agents of the state have treated foreign investors, Putin's ongoing geopolitical rhetoric with The West, and the invasion of Georgia, have all persuaded foreign investors to look elsewhere and that Russia is not worth the trouble.
Russia desperately needs more FDI to grow. Infrastructure and large commodity assets (oil wells/ mines) are in urgent need of technological upgrade and fresh development. Hence Putin's siren call for new foreign investment - he knows it can't be done without foreign equity.
So have things really changed? Is Russia really now less risky for foreigners to invest in and the aforementioned threats reduced? It doesn't seem like it. A mere few days after he was wooing foreign investors with the words above, Putin gave the following ultimatum to Renault regarding their investment partnership in Russian auto maker Avtovaz:
“Either they (Renault) participate in funding the enterprise or we will have to agree with them on dividing up our stakes”
Which leads me to the ongoing saga of Hermitage Capital and the systematic harassment they have suffered by apparent agents of the Russian state. Hermitage Capital is an active investment manager co-founded by William Browder. Their first fund, "The Hermitage Fund", founded in 1996 was at one time the largest foreign investor in Russia. The story of Hermitage is remarkable. And one where reality really is stranger than fiction. The following three pages published in the July 2008 Hermitage investors newsletter make fascinating reading:
But matters have progressed from over a year ago and the plot has thickened - all whilst Putin has been declaring Russia a great place for foreigners to invest. I was reminded of the Hermitage saga by a recent post over at Zero Hedge. This is what Tyler Durden had to say:
Additionally, after a protracted fight with the Russian government, today an arrest warrant was issued against co-founder William Browder under the pretext of the ever prevalent and Russian favorite allegation of "tax fraud." Recall this is precisely the reason why Yukos founder Mikhail Khodorkovsky is currently serving jail time. Hermitage has prepared the following video explaining the series of fascinating events that have led to the current fallout and today's arrest warrant. And for a more extensive overview of Hermitage's travails under Putin and now Medvedev, these two profiles by the Economist and the NYT are an entertaining read.
Despite the setbacks and the apparent state-backed harassment, Hermitage continue to fight. Clearly this isn't easy in a country with little rule of law and a corrupt judiciary - as the video shows:
So considering returns in Russia are typically a lot less than in other large emerging markets where investing is easier and less risky, does Russia offer risk premia commensurate to the real risks entailed? Probably not. Putin is going to have to do much more than offer words before FDI into Russia returns to levels last seen in 2007.
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