Issues & Challenges in Investing in Russia

ISSUES & CHALLENGES IN INVESTING IN RUSSIA

The waves of privatization in Russia in the 90s, resulted in drastic changes in its economical and political landscape. With an apparent lack of well developed legal and political infrastructure in Russia, it is imperative for foreign investors to consider several crucial elements before channelling funds into the country. To further exacerbate the situation, foreign companies such as Hermitage Capital Management would likely encounter insurmountable resistances from Russian oligarchs or bureaucrats and may ultimately be deemed as a "threat to national security" if it takes a tough stance against corruption.

The bigger problem is the sheer number of Russian government officials in collaboration with criminal group such as in the Hermitage case. This suggests the sophistication of state-sponsored finan¬cial crimes in Russia where bureaucrats could confiscate a firm's assets in an elaborate scam. As such, investors have grown wary of Russia's lawlessness, thus undermining their confidence in the country's investment climate.

ASSESEMENT OF ALTERNATIVES FOR INVESTING IN RUSSIA

I. Shareholder activism as an investor strategy

Against the backdrop of rising corruption and graft, potential entrants into Russia could adopt Hermitage's approach which goes beyond traditional fund management activity by aggressively focusing on corporate governance and shareholder activism. As illustrated by the Gazprom sage, the basic approach of Hermitage Capital Management was to research and comprehend the source of the corporate malfeasance, and subsequently share the stories with the press. By doing so, severe business, reputational and financial consequences would be inflicted on the incumbent firm. This could act as deterrence, thus preventing Russian oligarchs from adopting corrupted practices to enhance their company's position.

As Russian oligarchs sought acceptance in the international community by joining the World Economic Forum to seek positions on the boards of trustees of prominent international institutions, media campaigns have become an increasingly effective tool to combat governance abuses in Russia. Thus, it was vital for Russian oligarchs to maintain a positive image within the international community or risk being stripped of their designation when the international press release negative coverage of any civil lawsuits or alleging bribery.

Despite the effectiveness of using media campaigns to combat corruption, Hermitage only appropriated gains proportionate to their stakes while other minority investors could free-ride on their activism. In addition, since the costs of activism had to be incorporated in a fund's fee structure, it is highly improbable that a firm could afford to be an activist if others could copy the portfolios