Russia – A Golden Opportunity for the Isle of Man
Since the wholesale privatisation of state assets in the 1990’s Russia has created nearly 100 billionaires and over 136,000 millionaires. One third of the deposits stolen in the ‘smash and grab raid’ during the recent Cyprus bail out belonged to Russians, resulting in many honest businesses, hardworking individuals and reputable Russian banks losing a significant amount of capital.
Affluent Russians and the emerging middle class crave wealth management services not readily available at home, and with Cyprus’ reputation as a safe haven shattered, other offshore jurisdictions are fighting to fill the void. The Isle of Man must be proactive and act quickly if it is to gain a sizeable share of this $2 Trillion economy, as Oksana Voron MSc explains…
Russians Suffer Most in Cyprus Bailout
The recent crisis in Cyprus is well documented, as were the losses sustained by depositors, one third of whom were Russian. Moody’s estimate that $31bn of the $90bn on deposit in Cypriot banks at the end of January 2013, belonged to Russians. Whilst substantial for Cyprus, this represents 1½% of Russia’s $2 trillion economy and 2% of its domestic savings, according to Alfa Bank, Russia’s largest private lender.
Close business, cultural and religious ties with Russia, and its tradition of banking secrecy, have made Cyprus an attractive haven for Russians. The majority of Russian money in Cyprus comes from mainstream banks, private individuals, and small and medium-sized companies (the so-called “medium oligarchs”),who seek a safeguard against political and economic risk at home. Whilst it has been reported that some Russians (such as Alisher Usmanov – the richest person in Russia and quoted as utilising BVI based structures), will survive unscathed, the majority of depositors will pay a hefty price for the Cypriot failures.
Legitimate Russian businesses use Cypriot subsidiaries to handle foreign sales
Capital flight from Russia has intensified in recent years, reaching at least $50 billion in 2012. There is evidence to suggest that some Russian money in Cypriot banks has come from unsavoury sources; of particular note investigators hunting $230 million stolen in a Russian fraud uncovered by tax attorney Sergei Magnitsky traced millions to bank accounts owned by shell companies in Cyprus.
However, the vast majority are legitimate Russian businesses who use Cypriot subsidiaries to handle their foreign sales, thus avoiding cumbersome Russian regulations on such transactions. Those companies could now find their Cypriot accounts effectively frozen by strict new capital controls which could have drastic consequences for Russian businesses, according to Moscow-based financial research group Investcafe.
As reported by the Moscow Times, individuals and businesses are trying to find another safe place to protect their assets with Malta, Switzerland, Luxembourg, Cayman Islands, Dubai and Singapore, fighting to fill the void left by Cyprus.
To fully appreciate the current situation facing wealthy Russians, one needs to review its recent history. Mikhail Gorbachov instigated political and economic change when he came to power in 1985. The perestroika period that followed resulted in the break-up of the former USSR with several ex-soviet states declaring independence from Moscow and Gorbachov removed from power at the end of 1991.
Under Yeltsin’s leadership Russia’s financial and economic development turned to turmoil with the large scale privatisation of state-owned assets during the early 90’s. The ensuing lack of control resulted in the decimation of less profitable industries such as agriculture, textiles, and manufacturing, whilst others such as oil, gas, and commodities flourished. Control over the biggest companies was consolidated into the hands of a few businessmen.
The 90’s was widely regarded as a very destructive decade by most Russians. It started with monetary reforms of 1991 and 1993 where many lost money that was not exchanged during a limited time window and above the exchange ceiling, and continued through the devaluation in 1998. By 1998 the Kremlin was virtually bankrupt and defaulted on its obligations; many people and businesses lost money.
Russia’s Key Economic Developments:
- The Russian stock market was founded in the mid-90’s and still demonstrates all elements of an emerging market – high volatility and risk, low trading volume, overreaction, etc.
- Trust law was established in the 90’s – this made it possible to transfer property into trust but not the ownership; therefore owners cannot optimise taxes on their assets within the country.
- The period from 2000 to 2007 saw relatively stable economy growth; interest developed in investment and the first mutual funds were established. It was also a good time for the offshore business as investors sought the protection of more stable financial environments for their newfound wealth.
- The wealth generated since privatization is now filtering down and creating an emergent middle class representing some 10% of the population according to official statistics. Interestingly, independent research discovered that 40-50% of the population consider themselves as “middle class” despite failing to meet other criteria.
- According to Forbes Russia boasted an astonishing 96 billionaires in 2013, and occupies second place in the rankings behind the US but ahead of China. There are also over 136,400 millionaires which equates to some 95 millionaires per 10,000 head of population.
The rising middle class now face a new challenge – how to protect and manage their newfound wealth. The immaturity of the local capital market provides limited options and Russian investors view robust western financial centres as tempting propositions. Political, economic, and financial risks associated with keeping ‘all eggs in one basket’ are well understood and many investors look for safe havens elsewhere.
Whilst the opportunity to invest in foreign investment instruments does exist, its adoption is limited partly due to distance, the language barrier lack of knowledge and specialists in this area.
The Russian wealth management industry is in its infancy. It is not just the entrepreneurs who lack awareness of investment and wealth protection opportunities, as my limited primary research suggested, the same also applies to professional financial advisors.
Challenges for Russians
Putin actively supports the current global trend of “de-offshorisation”, his primary concern is in stemming capital outflows to offshore jurisdictions. Tax policy is tightening, common opinion is that “being offshore” is synonymous with tax evasion and dubious schemes are questioned by the tax authorities.
Putin supports global “de-offshorisation”
The Isle of Man has worked hard to promote itself as a highly regulated international financial centre. Despite being considered by the OECD as a reliable financial jurisdiction, it remains on the Kremlin’s blacklist. Russian organisations that have entities registered in the Isle of Man may be viewed as “suspicious” by the tax authorities and subjected to intense scrutiny including unplanned checks and financial penalties.
Russian investors face numerous challenges:
- Wealth management issues, investment principles, and other considerations that are taken for granted in more mature jurisdictions are not widely appreciated in Russia. Terms such as portfolio “diversification,” “optimisation” and “asset allocation” are only just becoming part of the investor’s vocabulary.
- Financial advisers generally have low qualifications and limited experience compared to their western counterparts.
- Investors interested in investment and wealth protection struggle to find reliable and trustworthy information they can act upon.
- Bad historical experiences and fear of losing capital have resulted in an overcautious approach – which the Cypriot experience has served to reinforce.
- Limited choice of investment vehicles: either the local volatile stock market, or low interest deposit accounts which create an illusion of security but do not protect against capital erosion due to inflation (7.2% in April 2013).
- Local banks offer investment opportunities through their private banking services, however, the minimum levels of investment and high fees put them beyond the reach of many investors.
- Few international investment houses have offices in Russia and those that do primarily offer the opportunity to invest in the Russian market to their international clients.
Less than 5% of Russians speak English
- Access to mature financial is limited due to distance and the language barrier – it is estimated that less than 5% of Russians speak English.
- From 2009 individuals could hold foreign bank accounts; however, from February 2013 new currency regulations dictate all income from foreign sources (including income derived from real estate abroad, fees, securities, mutual funds, and interest on deposits) must firstly pass through a Russian bank account.
- Pension time bomb: New state pension strategies introduce uncertainty; an emerging awareness of the need for robust retirement provision is provoking thought amongst investors.
A Golden Opportunity for the Isle of Man
The Isle of Man is a highly developed, well regulated mature international finance centre at the forefront of wealth management. Clients are typically introduced by intermediaries such as IFA’s, accountants, and solicitors and many CSP’s benefit from a well-developed and knowledgeable intermediary network built up through personal and professional contacts over a number of years.
The maturity of both the CSP’s and intermediaries complement each other well. Having access to Financial Advisors is commonplace in most European countries and the industry is subject to rigour and regulatory control which offers some protection for the investor.
By contrast, wealth management in Russia is an emerging discipline; independent financial advisors have a lot to learn and the general level of qualifications is quite low by comparison to the Isle of Man. Until this market starts to mature any form of regulation can only be minimal which, in turn, leads to levels of mistrust within the industry not experienced in mature markets.
Whilst some financial products such as FX trading and bank deposits are actively promoted locally, limited understanding of investment opportunities and wealth management can be partly attributed to the lack of informative, relevant, and engaging information in the local language.
The challenge for IOM based CSP’s wishing to tap into this lucrative market is building a competent and trustworthy network of Russian intermediaries. There is some evidence of Isle of Man based service providers with native Russian speakers making progress in this area.
The ‘English Method of Investing’ is gaining momentum in Russia
Equally, there are also Russian IFA’s who have recently established links with the Island and are proactive in promoting wealth management solutions to their client base in Russia, based on the so called ‘English Method of Investing’ – consisting of three core elements of a trust, insurance, and legal protection. This is being offered through a few Isle of Man based service providers and is gaining momentum.
Initially, CSP’s need to gain a greater understanding of their potential Russian clients as their needs may differ; legal, cultural, social, political, and economic differences also need to be considered. This will enable products and services to be tailored to the Russian market – which will be very appealing to the target audience.
Local language skills are critical success factor in building trust
Developing both the intermediary network and end client base will require differing degrees of education and separate ‘educational marketing strategies’ should be considered. Both target audiences are highly digitally active, therefore digital marketing strategies could be very effective in achieving the CSP’s business objectives.
Rich pickings exist for proactive CSP’s who are prepared to invest the time and energy in building a network of reputable Russian intermediaries. Having in-house language skills is a critical success factor to achieving this, particularly when preparing marketing, contractual, and management related documentation as one of the biggest fears identified in recent research was lack of trust.
This will inevitably involve some level of market education as the primary challenge is to match the needs of an emergent market with mature service providers.