A Deripaska-Sized Hint to Wealthy Russians

(Bloomberg Opinion) -- The story of the U.S. sanctions on billionaire Oleg Deripaska contains some hints for other wealthy Russians about how to conduct their international business despite President Vladimir Putin’s anti-Western stance. The main takeaway: Don’t hold controlling stakes in companies.

On Sunday, the U.S. Treasury Department lifted restrictions on En+ Group Plc, UC Rusal Plc and EuroSibEnergo JSC, saying it was satisfied with the way Deripaska (who remains sanctioned) has reduced his holdings in the companies and ceded his voting rights to independent, non-Russian persons.

The decision is politically unpopular in Congress, where Democrats argue that the divestments are a sham because the billionaire has handed over stakes to allies and, sometimes, to entities close to the Kremlin. The recipients of his shares include Russian state-owned bank VTB and a foundation created by the businessman. Since the announcement triggered a rise in the share prices of En+ and Rusal, the companies that run the vast aluminum business Deripaska has cobbled together since the 1990s, critics have called it a win for Putin.

The Treasury maintains that Deripaska won’t benefit from the deal. Any dividends he receives will be placed in blocked accounts. He will have voting rights over no more than 35 percent of shares in En+, his former holding company. VTB will cede its votes to an independent third party.

This means Deripaska really has given up control. Even if his ex-wife, her father and a firm linked to them vote with the billionaire, they still wouldn’t have a majority. Half of En+’s board now consists of U.S. and U.K. citizens vetted by Treasury, and Deripaska only has the right to nominate four out of 12 directors. 

There wouldn't have been any lessons to draw had the deal’s opponents prevailed and the sanctions not been lifted. But two things are now clear: the terms on which a wealthy Russian can expect to have U.S. sanctions on their assets lifted, and how those assets can avoid being sanctioned, even if their owner is. Admittedly, my analysis assumes a consistent U.S. policy. That may be too bold a premise in this era of uncompromising political strife, but it has to be made if one believes the U.S. to be a rules-based society.

Russia’s rough transition to capitalism created an ownership paradigm in which even public companies are often controlled by a single shareholder. According to a study by Deloitte in 2015, 73 percent of Russia’s 120 top public companies had a majority shareholder; 34 of the 120 were state-controlled.

Such concentration of ownership is partly the result of a grossly mismanaged privatization program, which, in its final phase, handed control of key assets to a small group of bankers in exchange for helping President Boris Yeltsin win re-election in 1996. But, to the same degree, it’s the result of a warlike business environment in which tough and quick decisions were a matter of survival.

That’s often the case in emerging markets with relatively weak institutions; in Indonesia and Brazil, for example, about 70 percent of public companies have a controlling shareholder. On the other hand, in Canada, only 25 percent of listed firms have a controlling shareholder; in Britain, less than 10 percent of companies traded on the London Stock Exchange have owners with 25 percent or more of the stock.

The concentration and the reluctance of majority owners to work with independent directors means minority shareholders’ rights are often ignored. That had depressed Russian companies’ valuations relative to their Western peers long before the annexation of Crimea in 2014 soured East-West relations.

What the Treasury did in the Deripaska case is to send a strong signal to move away from this post-Soviet tradition of corporate governance: to reduce the biggest shareholders’ stakes, to make sure the board is adequately populated by independent directors, and to ensure that voting rights are sufficiently dispersed.

That may be a hard pill to swallow for the survivors of Russia’s robber baron phase of capitalism, but it’s a powerful barrier against sanctions. If a company operates internationally, good corporate governance and a dispersed ownership structure are better protections against attacks than an owner’s ability to make speedy decisions.

Another lesson is to find and trust top Western professionals to build the new corporate governance systems. In Deripaska’s case, Gregory Barker, chairman of En+ and a former British government minister, played a key role in brokering the Treasury deal.

Without him, and the expensive lawyers and lobbyists he hired, Deripaska probably would have failed to convince the U.S. that he was ceding control. In a tough political environment, this isn’t so much a matter of connections as of building a convincing, legally watertight case: The public servants who provide Treasury Secretary Steven Mnuchin with the background for making decisions will want to play it safe.

The final lesson is that crawling back to Russia for the questionable safety it can provide is unnecessary. It is possible to satisfy Western regulators even in situations as fraught as that of Deripaska.

But then, Russian billionaires were reluctant to follow Putin’s advice and repatriate their money anyway. Direct investment from their eight favorite offshore havens – Cyprus, the Netherlands, the Bahamas, Bermuda, Luxembourg, the British Virgin Islands, Switzerland and Jersey – was only $306 billion as of July, up only slightly from $300 billion just before the annexation of Crimea, according to central bank data.

Sanctions against Deripaska’s companies or against the businessman himself couldn’t have changed Putin’s foreign policy. But if wealthy Russians can learn the lessons from the Treasury’s handling of the case, large public companies of Russian origin might be able to shed their unfavorable image, become more attractive to investors, and more acceptable as corporate citizens in the West. That would be a good outcome for a post-Putin Russia, too.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is Bloomberg Opinion's Europe columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.

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