This article appears as part of Private Equity International‘s December/January Emerging Markets special supplement.

Michael Calvey, founder of Baring Vostok Capital Partners, has not left his Moscow apartment – except for legal hearings – since August. The US national was arrested in February on fraud charges and later placed under house arrest. He was detained alongside five others, three of whom haven’t seen or spoken to their families in more than eight months. The group – which includes two former portfolio company executives – are not expected to face trial until 2020 at the earliest.

The allegations relate to the valuation of a company that was transferred from one of Baring Vostok’s portfolio companies, First Collection Bureau, to another, Vostochniy Bank. The firm has dismissed the claims as having no merit and a tactic in a dispute over the ownership of Vostochniy Bank with other shareholders.

Russia is no stranger to corporate disputes, more commonly known as reiderstvo, whereby the authorities are complicit in the – sometimes – illicit acquisition of a business, according to a 2014 report by the Chatham House think-tank.

State intervention is a narrative that has come to define not only Baring Vostok, but also the Russian private equity market. Local players and companies will be hoping that investors to the east are less fazed by the government’s shadow than their western counterparts.

Propped up

At first glance, Russian private equity appears to be ticking along. Deal values reached $571 million across seven transactions in H1 2019, with spending on track to exceed the $797 million deployed across 19 deals last year, according to the Russian Venture Capital Association.

The data flatter to deceive. State-backed funds were responsible for 73 percent of investments in H1 and 78 percent in 2018. The proportion of capital invested by vehicles with government ties has only fallen below 65 percent once since 2015, accounting for 58 percent in 2017.

Much of this spending has been driven by the $10 billion Russian Direct Investment Fund, which was created in 2011. RDIF became the country’s sovereign wealth fund in 2016, two years after the US, the EU and their allies imposed economic sanctions on Russia in response to its annexation of Crimea. These rules, which prohibit dealings with designated individuals and companies, were extended in June to at least 2020.

“Slowly but surely RDIF has begun to dominate the market,” Oxana Balayan, managing partner of Hogan Lovells’ Moscow office, tells Private Equity International.

It hasn’t always been this way: global buyout firm TPG Capital used to be a more familiar face in the Russian market. The firm acquired food retailer Lenta in 2009 and reportedly agreed to sell to steel tycoon Alexei Mordashov in April following a tumultuous period of ownership. It previously held a stake in state-owned lender VTB, which is under sanctions.

Finland’s CapMan was an active investor in Russia, having raised two vehicles dedicated to the country in 2007 and 2013. The firm completed 10 investments there between 2009 and 2014 inclusive, but only four since, according to its website.

Eastern promise

RDIF signed two of 2019’s largest investments in Russia, both of which involved the $940 billion China Investment Corporation, according to S&P Global Market Intelligence. The pair acquired stakes in mining business Intergeo and pharmaceutical company OBL Pharm for $100 million and $62 million, respectively.

The sovereign wealth fund has courted a host of other Asian and Middle Eastern investors, including Mubadala, the UAE’s $229 billion state investment arm, Kuwait Investment Authority, Qatar Investment Authority and Singapore’s Temasek.

“The Russian government spent tens of years convincing Western institutions how great Russia was, but all of a sudden these markets were closed off and it had to start all over again with Asian investors,” Balayan says.

“Investors might find the environment interesting, but also insecure. The obvious solution is to team up with a state-backed quasi private equity fund, because they know if anything were to happen there’s additional protection and a benefit to having that strong partner.”

Private equity fundraising has borne the brunt of western retrenchment. According to the RVCA, Russian funds oversaw $17.8 billion across 70 vehicles as of H1 2019, compared with $21.4 billion over 93 funds in 2013. No private equity funds dedicated solely to Russia have closed since 2014, PEI data show.

Limited partners also named Russia the least attractive emerging market in four of the past five years, according to EMPEA.

“There’s been a significant impact on the ability to raise funds and that obviously has a knock-on effect for investment,” Sebastian Rice, corporate partner in the London office of international law firm Akin Gump, notes.

Russia is home to few private equity players, the largest of which is Baring Vostok. The firm had been gearing up to raise its sixth fund at the time of Calvey’s arrest but has since put these plans on ice.

Elbrus Capital is another of Russia’s established players. The firm, which spun out from investment bank Renaissance Group in 2009, is seeking $600 million for its third private equity fund, PEI reported in October. Like RDIF, Asian and Middle Eastern investors are expected to play a more significant role in Elbrus’s latest fundraise, with those in the West likely to be a hard sell. European and US institutions account for 41 percent and 27 percent, respectively, of the firm’s existing $1 billion of AUM, which was raised pre-sanctions.

“It’s probably a little too soon to know what impact [Baring Vostok] had because there are so many other factors at play in Russia and global politics,” Rice adds. “We’ll know more as funds try to raise capital and start hearing what investors are saying about whether or not they’re willing to commit.”