Russia is going through a turbulent time. The socio-political backlash and actions following the annexation of Crimea have infiltrated the economic environment. This is impacting the country’s private banking sector that has strong potential, yet is riddled with challenges. Can Russia’s wealth management industry pull through the current strife and emerge stronger? Patrick Brusnahan investigates.
It is a turbulent time for Russia. Russian military intervention in the Republic of Crimea, leading to an annexation of Ukrainian territory, has put the country under the magnifying glass and all the cracks are visible.
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The US has issued sanctions against Russia that the EU has endorsed, adding several restrictions on the economic front. Russia’s credit outlook has, unsurprisingly, been downgraded by both Fitch and Standard & Poor. Large companies in the country have suffered heavy losses, such as Russia’s second largest gas producer, Novatek, that had $2.5 billion of its market value wiped out.
Despite unfavourable market conditions, the wealth management market in Russia is still, relatively, gathering prominence and pace, largely due to the amount of wealth present within the country.
Russia’s wealth management sector is still in its youth – having only been established in 1991 after the collapse of the Soviet Union.
According to sister company WealthInsight, Russia is currently home to over 160,000 high net worth individuals (HNWIs) with a total of $1.1 trillion in wealth. This number is set to grow 4.5% by 2018 and reach over 170,000 with wealth increasing by an even larger 17% to $1.4 trillion.
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By GlobalDataAdditionally, WealthInsight reports that there is a small pool of 1,318 ultra high net worth individuals (UHNWIs) with an average per capita wealth of $454.5 million.
In the last decade, the wealth management and private banking sectors’ growth have been driven by the volume of wealthy individuals present in Russia. In 2013, 21.4% of all domestic HNWIs created their wealth through this sector, an increase of 52.5% from 2009.
The only industry that came close to this percentage was the basic materials sector with 13.3% of HNWIs working in this field. While signs do point towards a flourishing wealth management landscape, currently, there are also obstacles to overcome.
Current roadblocks
There are a number of factors hindering the development of the private banking sector in Russia.
Lack of transparency, wavering foreign economic policy and high levels of governance have resulted in struggles within the wealth management industry. The major domestic banks, such as VTB, with over $9.6 billion in assets under management (AUM), and Sberbank, are majority owned by the Russian government that remains highly involved in their businesses.
The government’s interference with the lenders’ operations has led to big foreign banks, two examples being Barclays and HSBC, withdrawing from the region in February 2011. A sparse number of foreign banks with a strong brand, such as Swiss lender Credit Suisse, have managed to remain in Russian market by attracting the UHNW customers, but it also had to move its investment bank out of Moscow to London in 2012.
There is also Societe Generale’s Russian subsidiary Rosbank that is a foreign player, alongside Italian lender UniCredit and Austrian bank Raffiesen that operate in Russia’s private banking space. However, they have not managed to penetrate the market significantly, and have, mostly, been losing clients to local lenders.
Additionally, due to the bureaucratic nature of Russia’s all-round banking operations, as well as ongoing socio-political tensions leading to diplomatic strife between Russia and the US and UK, entry of foreign banks into the private banking market could, potentially, halt altogether.
Up to speed with regulation
Despite problems with the lack of transparency, Russian banks have been fairly compliant with regulation.
The Central Bank of Russia implemented Basel III at the start of 2014 in order for banks to be stress-tested. In addition, the Foreign Account Tax Compliance Act (FATCA), which was implemented in June 2014, added a level of co-operation with US authorities and has injected a degree of transparency to the domestic private banking industry.
Both these steps convey Russia’s desire to move forward and comply with international standards in private banking.
Russia is also taking steps towards reducing the government’s interference in its banking operations, in an attempt to make the region more appealing to foreign investors. The government has increased its expenditure on technological start-ups, as well as reduced its ownerships of VTB and Sberbank. This offers a degree of promise to private banks, both domestic and foreign, that the Russian market is on course to becoming more open and transparent.
Despite redeeming steps, much of Russia’s wealthy population has moved and is continually moving capital into more prosperous nations, especially in Asia.
Olga Degtyareva, CEO of URALSIB Private Bank, says: "About 80-90% of Russian millionaires prefer to keep their assets outside of Russia. This is a certain challenge for Russian private banks."
Nick Rucker, partner at Berkeley Law, says: "Because of concerns about the rule of law and new legislation on disclosure of information about citizenship anywhere other than Russia and controlled foreign entities, Russians are increasingly trying to get out of Russia so that they are not subject to these issues."
However, one of the most immediate threats to the stability of private banking in Russia is the recent sanctions against the country.
It has had a ripple effect across all of the financial services segments – not just in Russia, but also across other parts of Europe.
Rucker says: "They will hurt Russians still residing in Russia as well as those looking to expand operations outside of Russia at this time."
Reetu Khosla, global director at software provider Pegasystems, also says: "Russian investors will be faced with enhanced scrutiny as they are engaging in business with private banks, especially from a due diligence perspective which may lengthen the time to transact as they are checked against the sanctions list.
"There may be also requirements of enhanced scrutiny on their transactions to ensure no sanction violations such as payments to sanctioned individuals or entities are processed through the bank. This may result in significant delays in doing business and transacting."
In terms of investors staying in Russia, Khosla adds: "Such complications may push wealthy Russian investors out of the European banking sector and force them to seek private and other banking services in other markets."
Khosla warns that the private banking markets in UK and France – that having significant financial dealings with Russia – will also be negatively affected due to the recent sanctions. "The compliance burden and the diminished customer service on high value customers resulting from the new sanctions can only hurt the private banking sector in large UK and European markets."
Changing tide
In order to attract new investors and clients, wealth managers are attempting to enhance their reputation and change their operating styles. The traditional methods of private banking in Russia are being challenged.
Degtyareva says: "In the last decade, the major change has been the gradual shift from the VIP service to genuine private banking and wealth management standards."
The main consequence of this is a shift has been a move to an advisory model of private banking. Increasingly, HNWIs are favouring deeper engagement with wealth managers, firms and advisors and private banks need to adapt to this trend to secure and sustain more business.
Additionally, there are other client and market demands that must be met. Degtyareva says: "Today, one of the key market trends is increased demand for financial instruments with law risk, primarily financial instruments with fixed income and structural products with guaranteed returns. One more which is worth mentioning is the change of generations. In response, we have developed a program that educates young people to manage family assets."
An interesting, and encouraging, factor in the Russian private banking market is the high level of mergers and acquisitions (M&A) that highlights a drive for growth within the industry.
The rapid growth within the country over the past 20 years has made Russia’s private banking conditions more favourable and an increasing number of banks are seeking to gain minority stakes in smaller banks. M&A activity in 2013 was high as many domestic wealth managers and private banks sought to expand the size of their portfolio through acquiring smaller companies.
This is in contrast to other regions within the European market that have been rather conservative after the 2008 financial crisis, such as Sweden, which only saw one acquisition in entirety in 2013.
The difference can be attributed to government involvement in the banking sector, which allowed institutions such as Otkritie, one of Russia’s largest financial groups, and Sberbank to stay active in partnerships and acquisitions. Moreover, interestingly, Russian private banks are also seeking opportunities to expand beyond domestic grounds into other emerging economies.
Opportunities ahead
Overall, Russia is experiencing a period of rapid transition. While the private banking sector is still young, it is growing up fairly quickly. With the burgeoning wealth and the potential present in the country, opportunities for private banks and wealth managers are rife.
However, current unrest within the country – specifically struggles in the wealth management sector – are holding back progress. With an additional layer of difficulty added by the ongoing socio-political turmoil in the region, it could be easy to, currently, rule out Russia as being a potent international player in the private banking arena.
On the other hand, global regulations are being quickly enforced and developments to the traditional private banking models are being made in Russia, suggesting an awareness of what needs to be done to remain relevant in the global private banking landscape, as well as a commitment towards doing so. The changes need to, potentially, be made at a pace that results in more fully realised opportunities as opposed to ones that are missed.
