EBRD poised to wind down Russia operations if sanctions extended

EBRD poised to wind down Russia operations if sanctions extended
EBRD headquarters in London.
By Jason Corcoran in Moscow April 22, 2016

The European Bank for Reconstruction and Development (EBRD) is poised to start winding down its operations in Russia if the European Union in June renews its sanctions against the Kremlin over its involvement in the Ukrainian conflict.

The sanctions, which will expire on July 31, are widely expected to be rolled over at an EU meeting in June – an event which would trigger a review of the bank’s policy on Russia, with leading board members said to favour an exit, EBRD insiders told bne IntelliNews.

“Some senior figures at the bank want us to wind up,” an EBRD insider told bne IntelliNews. “There’s been some in-fighting about it because management on the ground in Moscow want to carry on. If the sanctions are renewed in June, we will have to cut down on our staff numbers in Russia.”

Jonathan Charles, EBRD managing director, communications, commented:"We are committed to servicing our existing portfolio in Russia. The question of whether the bank can resume investing in new projects in Russia remains a matter for our shareholders."

The EBRD is owned by 65 countries, the EU and the European Investment Bank, but the countries with the largest stakes are Germany and the UK with 9.5% each, and it’s said that politicians from the major European capitals exert great influence over the bank’s Russia policy. The US, which is much more strongly opposed to active EBRD involvement in Russia, also carries great weight.

The London-based lender was set up in 1991 by Western governments to help former communist countries make the transition to capitalism. Last year was the first full year in which the bank brought no new projects to Russia – once the single largest recipient of annual funding – after a majority of the shareholders decided to halt new funding in July 2014, following Russia’s seizure and annexation of Crimea from Ukraine.

“You could argue there is no need for the EBRD to be in Russia because Russia has a lot of money for infrastructure funds and other countries need them more,” Tom Adshead, chief operating officer at Macro Advisory consultancy and a former EBRD banker, told bne IntelliNews. “I doubt the EBRD is running for the hills, but these are not good investments to be in.” 

The EBRD’s Russia portfolio, its second largest after Turkey, has shrunk to €5.35bn from €6.3bn a year ago following a number of exits. About 56% of its portfolio is made up of debt, with the remainder public and private equity investments. About 83% is invested in the private sector, with just 17% held in state-controlled entities.

The EBRD has faced greater challenges in its 25 years in Russia. Its entire $2bn portfolio was all but wiped out in 1998 after the Kremlin defaulted on its sovereign debt.

In the wake of the 2008 global financial crisis, the EBRD was one of the few international lenders willing to step in and play a crucial role in stabilising Russia’s economy by taking stakes in systemic banks and companies.

But any retreat now from Russia, which is in its second year of recession, would be “madness”, according to a senior EBRD Moscow insider. ”If they announce they are winding down in June, there will be a fire sale and they will get nothing for it,” the source told bne IntelliNews

However, another insider told bne IntelliNews that there was no question of a fire sale and no plans for big job cuts or office closures.

The EBRD’s sale in April of its 9.25% stake in Russia’s TransContainer marked the end of a troubled investment in which it lost more than $100mn. Analysts and investors were surprised at the timing of the sale, given that company is being primed for further privatisation following a recent management overhaul.

“The shares are awakening from a hibernation and profitability should improve this year,” Denis Vorchik, a Uralsib Capital analyst, wrote in a report on April 19. “In contrast to the rail market for liquid cargoes, the long term fundamental growth potential of the rail container market remains intact.” Uralsib upgraded the stock to a ‘buy’ rating and cited a 40-50% discount to TransContainer’s international peers.

Not alone

The EBRD isn’t the only international financial institution facing a crossroads in Russia. The IFC, the World Bank’s private equity arm, is in a similar position, having frozen activity in Russia while being a co-investor with the EBRD on many Russian deals.

The IFC sold its 15% stake in Loko Bank, Russia’s 68th largest by assets, according to a Vedomosti report on April 19. This came after it exited its 3.3% stake last year in MDM Bank and its 3% stake in Orient Express bank.

The EBRD has significant exposure to Russia’s financial sector through its equity stakes in more than a dozen lenders as well financing arrangements. Some of the banks like Promsvyazbank and Credit Bank of Moscow look like safe bets as they became consolidators of smaller, weaker players.

One of the key problems for these international financial institutions has been the closure of the IPO and merger and acquisition markets, so the emergence of any kind of buyer makes it tempting to cash out. The EBRD last year also sold its stake in utility Enel Russia and cut its holding in hypermarket chain Lenta.

Some of the EBRD’s exits have also been hit by transactions costs as many of the original investments were made in foreign currency.

The EBRD has also cooperated on a number of projects with Vnesheconombank (VEB), the troubled development lender that is seeking a RUB1.2 trillion ($17.34bn) bailout from the Russian government.

Many EBRD projects in Russia are aimed at the country’s regions, where the recession has hit the hardest. Structural priorities include support of technological modernisation of non-energy sectors, science-intensive and high-tech production, transport and municipal infrastructure.

Quite a few projects are understood to be in corporate recovery, but insiders said there had not yet been any write-downs.

The bank has a staff of about 80-90 in Moscow, although many have been reassigned to work on Kazakhstan and other countries in Central Asia since the freeze on new Russia investments. None of the seven offices in Russia have been closed so far.

The EBRD has expanded its activities in recent years to include Mongolia, Turkey, Greece and Cyprus, as well as countries affected by the Arab Spring uprisings, such as Egypt, Morocco and Jordan. In 2014, the EBRD also suffered its first annual loss because its portfolio in Russia and Ukraine had tumbled.

Key to the EBRD’s future in Russia is the likely re-election of the bank’s president, Sir Suma Chakrabarti, for another four-year term at the lender’s annual meeting in London. Chakrabarti, is expected to triumph in a run-off against Marek Belka, the current governor of the National Bank of Poland, on May 11 at its annual meeting in London. Chakrabarti, a British national who was born in India, is said to have run the rule over extending the EBRDs remit to even more far-flung countries, including Burma and Singapore. China joined as a member in January.

The Czech Republic is the only member to have “graduated” from the EBRD and no longer receives investment from the bank. But the argument for leaving could be made for Poland and Russia, which is in good fiscal shape despite the recession and has its own sovereign funds investing in infrastructure and private equity such the Russian Direct Investment Fund.  

“I doubt they will be doing much [in Russia] for some time – well, until the US elections and Brexit are out of the way,” Tim Ash, Nomura, head of emerging market strategy at Nomura International, told bne IntelliNews. “They are part of lines in the sand for a reset in Russia-Western relations.”