The Yukos affair has been characterized in the international media as an anti-business offensive by an authoritarian regime that will drive away foreign investment and bring Russia’s economic and financial recovery to a grinding halt. The reality could not be more different, says William Browder. It is a welcome move to wrest control of the country back from a handful of unelected and self-interested oligarchs, by a president who has already done much to stabilize Russia and improve its economic and business prospects
Of the many big problems facing Russia today, the battle that president Vladimir Putin has been fighting to stop the oligarchs from taking over the country is among the most important. Nowhere is this battle more emblematic than in the current fight between Putin and Mikhail Khodorkovsky, Russia’s biggest oligarch. The way in which it is resolved will influence Russia’s development for the next decade.
There has been much sympathy for Khodorkovsky — particularly from outside Russia — as people have focused on the selective nature of his arrest, the methods by which he was taken into custody and the strange behaviour of the authorities in the process.
A wave of panic and fear for Russia’s future initially washed over investors and analysts, with share prices falling sharply amid concerns that foreign investment into Russia would be driven away and that political interference would taint Russia’s economic and business revival.
But the fear is unfounded. Putin’s approach to this conflict is consistent with what is right for Russia. One needs only to look at the record of the two men in question — and what their goals and actions have been — to see that Putin is only doing what any leader would do to further his nation’s interests.
In one corner stands Khodorkovsky. He may have become the poster-child for Russia’s corporate clean-up in the past two years, but his activities in the mid 1990s tell a rather different story.
During that period, Khodorkovsky’s name became synonymous with corporate governance abuse. I used to present his story at international corporate governance conferences as a prime example of why investing in Russia was so fraught with danger — and why the Russian government at that time was inept at protecting investors like myself.
Khodorkovsky’s chequered history is no secret. His best-known deal – and the one that made him fantastically rich – was his acquisition of the Yukos oil company from the Russian state.
In 1995, while president Boris Yeltsin was still in charge, Khodorkovsky’s Menatep Bank bought at an investment tender a 33% stake in Yukos for $150 million. At the same time, at a loan-for-shares auction, Menatep lent $159 million to the Russian government, which was allegedly suffering from a cash shortage at the time.
In return for this loan, the government pledged its 45% stake in Yukos as collateral. That in itself was dubious because, at that time, Russian government agencies were keeping money with Menatep Bank – so that this loan facility was at least partly financed by the government’s own funds.
A year later, in December 1996, the government announced that it was “defaulting” on the loan and that Menatep would have to auction the government’s Yukos stake to get its money back.
So Menatep duly organized an auction. Unsurprisingly, the winner was a company associated with Khodorkovsky – which paid an ultimate price of $160 million for the 45% stake and also promised to invest $200 million in Yukos.
As a result, Khodorkovsky acquired 78% of Yukos for just $310 million. Eight months later the same stake was worth $12.6 billion. At today’s prices, it is worth $21 billion.
If that were his only questionable deal, one could perhaps forgive it. But it wasn’t. There were others. In 1998, when the banking system collapsed, Menatep defaulted on its obligations to depositors.
Khodorkovsky could have blamed external factors for the collapse of his bank, but those external factors certainly could not justify the transfer of the main banking buildings in Moscow to newly formed banks that he controlled, at a time when his depositors were receiving next to nothing.
Another example came in 1999, when Yukos attempted to divert between 66% and 80% of its major subsidiaries through dilutive share issues to offshore companies controlled by Khodorkovsky’s associates as a way to squeeze out minority shareholders.
Most investors in Yukos and its subsidiaries, including my fund, believed that we were going to be left with nothing when the dilution plans were implemented.
After Khodorkovsky had collected an enormous pile of cheap assets from the government and minority shareholders, he embarked on an impressive charm and lobbying offensive to legitimize himself and his wealth. He was largely successful in getting people to forget his not-so-distant past.
Now let’s look at Putin. When he first came to power in 2000, people questioned his intentions in the light of his KGB past. Analysts made dire predictions about the direction in which he was going to lead Russia – forecasting a more authoritarian, less business-friendly climate.
The country was in a state of chaos. The state had no money because all the sources of income had been stolen. Workers and pensioners had to wait months and even years to receive money due to them. Hospitals and universities were being run on skeleton staff and even the armed forces were bankrupt.
The expectation was that Putin was going to add to people’s misery by maintaining the status quo of poverty and graft – while also adding some heavy-handed KGB authoritarianism into the mix.
The reality took everyone by surprise. Instead of pushing Russia back, Putin implemented a reform programme that was far more liberal than anything that could have been cooked up by the most radical think-tank in Washington.
In 2000, he cut the individual income tax rate from 35% to 13% – and, in the process, collected 49% more tax. He changed the land code, the labour code, the customs code and the country’s securities laws.
Workers started receiving their salaries, companies paid their debts and the economy grew by 29% in his first four years. He also leaned much further towards the west than any of his predecessors.
He pledged to join the WTO at the earliest possible date, he announced the goal of making the rouble convertible by 2006 and he has repaid $30 billion of foreign debt over the past four years. Perhaps most important, from the perspective of an investor, he is clearly not acting merely in his own financial interests in the way that we have seen other Russian government officials do in the past.
When minority shareholders of Russia’s electricity monopoly, Unified Energy Systems, were facing the prospect of having their assets stripped by the company’s management as part of a highly suspect restructuring plan, it was only after Putin stepped in that we were made whole again.
It has been my experience that minority investors have generally had very few friends in Russia. But, fortunately for us and for many others like us, Putin has been one of them.
Insofar as there has been opposition to Putin’s economic reforms, it has come from two camps – one of these being the communists. Fortunately, they have been gradually drifting into oblivion as their constituency has been lost to other parties.
The other camp consists largely of the oligarchs, whose influence has risen to dangerous levels. Most of the oligarchs are interested in only two things: preserving their wealth and avoiding having to share it in any way with the state and the public.
As the richest oligarch, Khodorkovsky was particularly vocal in his own self-interest. He went from being one of the most sharp-elbowed people in the corporate world to being the most zealous and influential in the world of politics and lawmaking.
In 2001, when the Duma was considering taxing oil companies according to the age of their fields, lobbyists successfully blocked that amendment – thereby giving Yukos, and several other companies, a big advantage over companies with older oil fields.
In 2002, when the Duma was considering a new law on taxing oil products, the lobbying machine again went to work in opposing the law and tariffs on oil product exports. As a result oil product exports remained capped until recently.
When the Duma tried to close a tax loophole involving Russian onshore tax-free zones at the same time as cutting the corporate profit tax rate at the lowest possible level of 20%, Yukos was allowed to keep paying an effective tax rate of 13% when Lukoil was paying 32% and Surgutneftegaz 25%.
It is not surprising that Putin stepped into the fray in 2003 when Khodorkovsky started actively financing the campaigns of various opposition parties in the recent Duma elections. Khodorkovsky has spoken loftily about his desire to encourage a pluralist system and the emergence of democracy in Russia.
He may very well be sincere in this aim. But Putin could not be expected to sit back and watch one unelected person use his wealth in a manner that could have such dire outcomes for the state.
So, as all the controversy rages about who is good and bad in this affair, we have to ask ourselves one key question – who do we trust to act in the best interests of the Russian people?
Is it an oligarch who amassed a personal net worth of $8 billion from nothing over an eight-year period – and who has used every tool available to enhance his wealth and avoid sharing his good fortune with the people of Russia?
Or is it a president who has a four-year track record of bringing Russia back from the brink of collapse – and who has succeeded in creating a relative degree of stability for his battered and tired citizens?
Some observers have come out in favour of Khodorkovsky – notably in the international media, where the affair has been characterized as an anti-business manoeuvre by an authoritarian government.
But that is not the position taken in Russia – either by the business community, or by the people at large. At the moment, Putin has an 82% approval rating, which was enhanced by 8% after the arrest of Khodorkovsky. The business community has also shown strong support.
Under Putin’s leadership since 2000, rouble interest rates have dropped from 38% to 7%, the stock market has gone up by 122% and Moscow real estate prices have doubled. His leadership has been good for business – and the business community knows that. The fear of economic disaster in the wake of the Yukos affair never materialized. There was no capital flight. And the central bank’s reserves grew by $7 billion in the weeks following Khodorkovsky’s arrest – reaching a record of $71.8 billion in mid-December.
Rouble interest rates have stayed flat, at 7%. The rouble has strengthened against the US dollar, from 29.90/$ to 29.30/$. Perhaps most important, from my own perspective, my fund has seen the single largest inflow of new money since 1997 – suggesting that people view the Khodorkovsky arrest as a change for the better, rather than the beginning of the end.
Looking into the future, Putin still has enormous challenges facing him. Among the key ones are establishing the real rule of law and a functioning judiciary, lifting the discriminatory ring-fence of ownership at the gas giant Gazprom and developing a sound banking system.
But the one challenge he has successfully addressed is that of the oligarchs. Putin understood that Russia would never succeed with seven oligarchs effectively at the helm of the country – particularly since their interests were so contrary to that of the nation as a whole.
He has set clear limits to the oligarchs’ power and their ability to meddle with the state. There may be some aspects of Putin and his policies with which we disagree. But, in this instance, we should give him the benefit of the doubt – and give our full support to the task he has set himself of taking back control of Russia from the oligarchs.
William Browder is the founder and chief executive officer of Hermitage Capital Management, which manages the Hermitage Fund — the largest Russia-dedicated equity fund, with $1.2 billion under management. His position on corporate governance practices in Russia has made him a leading shareholder rights activist and an outspoken campaigner for better corporate governance.