Sbroika tips the scales on Russia's investment bank barbell

By bne IntelliNews July 9, 2012

Ben Aris in St Petersburg -

The Russian investment banking market has been totally transformed in the last year. From a vibrant playground filled with scrappy and largely privately owned broker deals, it is now suddenly dominated by two state-owned giants, with the rest fighting for the scraps.

VTB Capital (VTBC) was set up just ahead of the 2008 financial meltdown, and hired the bulk of Deutsche Bank's Moscow team in one lot to kick things off. An offshoot of Russia's second largest retail and corporate bank, VTBC expanded aggressively, and today is clearly the leading investment bank in Russia.

However, it now has serious competition. Last year, Russia's biggest retail bank - and one of the biggest in Europe - Sberbank decided it needed to get into the investment banking game. It took a slightly different route, buying existing investment bank Troika Dialog, the merger of which was formally completed in May.

Now the game is on to see which of VTBC and Sberbank's new operation (nicked name Sbroika until it is given a new official name) will emerge as top dog. VTBC has a good head start, but Sberbank is a behemoth and has significant clout in the worlds of both business and politics.

Time at the barbell

At first glance, the marriage that created Sbroika looks like the Kremlin increasing its clout in the economy again - and indeed that is one of the results. However, it also follows current global trends.

In these lean times, companies are asking themselves why they are paying fat fees to standalone investment banks for services they can now get from their corporate bank. Meanwhile, with margins suffering on the back of new regulation following the crisis, the banks serving the corporate segment are also keen to move into the fee-paying business.

Around the world, banks are beefing up their investment bank services, while investment banks are moving in the opposition direction. For example, Goldman Sachs - the archetypal investment bank - has started to lend its customers money, a very mundane service for such a quixotic entity. The reason is that thanks to the credit crunch, lenders suddenly find themselves in a strong position. "There has to be an absolute integration with Sberbank, as that is our competitive advantage: the combined bank lends to the companies but at the same time can now offer investment bank services. Credit is scarcer than it used to be, so now the lender has more power in the game," Rob Leith, managing director and global head of investment banking and global markets at Troika Dialog, told bne in an exclusive interview during the St Petersburg International Economic Forum.

However, without doing the nuts and bolts business, it is hard to add the fee-paying operations, Leigh points out. That's a dilemma neatly illustrated by the problems experienced by Troika's erstwhile rival Renaissance Capital (or Rencap).

For most of the last decade and a half, these two privately owned investment banks have slugged it out over market share, with Rencap perceived as better with the international portfolio investors and Troika more on top of the domestic scene. However, Rencap has been reeling since the crisis. It nearly collapsed in 2009, when owner Stephen Jennings was forced to sell half the bank to oligarch Mikhail Prokhorov.

It went on to lose about $30m in 2010 and another $100m in 2011. A wave of sackings early this year have stabilised the situation, says Jennings, but he has also talked of a "killing zone" that is appearing in the investment banking sector thanks to the crisis-induced shakeout. It's a theory doing the rounds in many banking segments these days, with the deaths of all but the very biggest, or the smallest boutique operations, forecast. "The industry will end up a barbell," Jennings predicted at the St Petersburg shindig, "with a small number of these enormous, essentially commercial, banks, which have investment banking operations on one end. On the other, you will have much smaller, primarily private businesses, and the accent will be on relationships, reliability, high levels of service, and entrepreneurialism, which harks back to an earlier era. The killing zone will be in the middle."

Just where Rencap sits in this battle is open to debate. Jennings is in the midst of totally restructuring the bank's business, according to bne sources - but clearly Sbroika is one of those "enormous, essentially commercial banks, which have investment banking operations," and would have to do something really stupid not to prosper.

Timely development

The merger with Sberbank was timely for Troika; since the crisis broke in 2008, life has been hard for most investment banks, and the ongoing trouble in Europe has only extended the struggle. "In M&A there are notable levels of activity, but the market is very jittery," Oscar Ratsin, deputy head of investment banking and head of M&A and ECM at Troika says. "There were some large cross-border deals last year, but this year there has been a lot less so far. International companies are preoccupied with domestic problems and risk aversion; Russian players have been more active since March 2012, but time slippage on deals is obvious. The pipeline is reasonably full and growing but the risk weighting is high, so the outlook for M&A business in 2012 is still uncertain. A number of big deals have been postponed, but Sberbank/Troika are well positioned for the market comeback with a strengthened team."

The timing of the deal is also pertinent from the perspective of the next likely stage of development for Russia's banking sector. If the 1990s were marked by deal making in the midst of the cut and thrust of transition, the next decade is going to be all about institution building. In April 2008, the Kremlin launched an overhaul of the capital markets that has already resulted in the merger of the country's two biggest exchanges: the RTS and MICEX. A central securities depository (CSD) has also finally arrived, and a design to create domestic institutional investors could transform the markets.

"The challenge is to develop over the next five to 10 years a domestic institutional investor base," states Todd Berman, managing director and head of investment banking at Troika. "This is a big country with 143m people, but the average Russian citizen has virtually no exposure to the equity markets. They don't invest directly or through the pension system, so they have no skin in the game. There is a lot of money in Russia today, but it isn't being funneled to portfolio investments."

That is where a bank like Sbroika comes in. Investment banking over the last two decades has largely catered to the needs of big foreign portfolio investors or local banks that wanted to take a punt on the wild, but highly profitable - providing you got your timing right - Russian equities market. No one had a long-term horizon; everyone was a speculator. That left the market volatile and prone to wild swings: Russia's stock market is only ever in the best three preforming markets in the world - or the worst three.

If Russia is to build a fully developed economy, it needs to persuade the population to get involved, and what better institution to do that than an investment bank that has a branch on every corner of every high street in the country, and already holds half of all retail deposits? "Mutual funds, private pension funds, private equity funds and other domestic institutional investors are simply too small in Russia relative to the size of the economy or the country. There are really only a very small number of meaningful professional investors in the whole country," says Berman. "Until Russia develops a substantive base of domestic institutional investors, Russian companies will continue to be dependent of foreign capital and will go to London or elsewhere to list their shares. There needs to be a fundamental change in the way the market works and the development of local capital - local investors for local companies. You can't finance the growth needs of Russia without domestic equity investment."

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