While a huge surge in private equity activity in Russia could never have been expected as long as Western sanctions related to the conflict in the Ukraine remain in place, the level of private equity activity in Russia remains surprisingly low.
Local players dominate the industry. Where there has been interest from overseas investors in Russia, including from China, India and other eastern jurisdictions, it has been from predominantly strategic investors rather than private equity. For instance, Chinese investors are usually state-owned enterprises rather than private equity firms, often targeting commodity assets or looking for a route to market in Russia for their own products.
Despite expectations that there would be a lot of sell-side mandates for lawyers and investment bankers to connect Russian and global capital with distressed assets, there has been a lack of desire to sell.
There are at least two driving factors behind this lack of appetite. Firstly, there is a substantial gap between buy-side and sell-side price expectations.Then there is the foreign exchange risk caused by the tumbling ruble, despite companies operating in a number of currencies, including dollars and euros.
Alternative sources of funding
Despite the clear demand for alternative sources of capital and the slowdown in the public markets, historically the favoured route for local companies looking to raise capital, private equity remains untapped as a financing solution.
Beyond geopolitical factors, in terms of business culture, private equity has yet to make an impact. In contrast, an initial public offering is widely perceived as a flashier way to raise a business’s profile.
Unlike Western markets, where private equity is often an early step for SMEs on a longer journey toward the stock exchange, Russian companies tend to skip that step. Local companies are often owned by a closed or small group of shareholders who decide to go straight to market. The ownership structure does not typically change much even after the company has gone public. Neither do the rules and customs by which the company operates.
This is regrettable as companies are often not ready to carry the burden that comes with being a public entity. It is one of the reasons behind an increase in de-listings from the Russian stock exchange.
The Russian government and regulators are working to make it more attractive for investors to bring their investments onshore through changes to the regulatory environment. These include amendments and clarifications, inter alia, into anti-trust and strategic enterprise laws as well as practice, and a controversial campaign against offshoring.
In addition, they are putting a legal framework in place that is more akin to Western models that offer investors better protection when putting capital at risk. Newly adopted civil law instruments include representations, warranties, indemnities, option agreements and the like, which are customary for private equity transactions.
The realisation that private equity is an untapped solution and that the regulatory environment needs to be made more attractive to foreign investors is a great start, but it will take a few more years before the situation starts to catch up with Western counterparts.
The key would be improved and more open-minded contract enforcement practices in courtrooms regarding complex commercial arrangements that quite often go well beyond any sophisticated law or code. Private equity transactions are an exceptionally good example of some of those.
Anton Sitnikov is a partner and head of corporate/M&A at Goltsblat BLP based in Moscow.